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UBC Theses and Dissertations

An examination of the Vancouver money market Blakey, Kenneth Clifford 1971

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AN EXAMINATION OF THE .VANCOUVER MONEY MARKET by KENNETH CLIFFORD BLAKEY B.A., Waterloo Lutheran U n i v e r s i t y , 1970 A T h e s i s Submitted as P a r t i a l F u l f i l l m e n t of the Requirements f o r the Degree of MASTER OF BUSINESS ADMINISTRATION i n The F a c u l t y o f Commerce and Business A d m i n i s t r a t i o n We accept t h i s t h e s i s as conforming t o the r e q u i r e d standard THE UNIVERSITY OF BRITISH COLUMBIA NOVEMBER 1971 In present ing th i s thes i s in p a r t i a l f u l f i l m e n t of the requirements for an advanced degree at the Un ivers i ty of B r i t i s h Columbia, 1 agree that the L ib ra ry sha l l make i t f r ee l y ava i l ab le for reference and study. I fu r ther agree that permission for extens ive copying of th i s thes i s fo r s cho la r l y purposes may be granted by the Head of my Department or by h i s representat ives . It is understood that copying or pub l i c a t i on of th i s thes i s f o r f i nanc i a l gain sha l l not be allowed without my wr i t ten permiss ion. Department of The Un ivers i ty o f B r i t i s h Columbia Vancouver 8, Canada ABSTRACT T h i s study, an examination o f the Vancouver money market, addresses i t s e l f to the fou r o b j e c t i v e s o f p r o v i d i n g a d e s c r i p t i o n o f the o v e r a l l s e t t i n g i n which the Vancouver money market e x i s t s , d e s c r i b i n g the Vancouver money market, i n d i c a t i n g the major p e c u l i a r i t i e s and i m p e r f e c t i o n s which e x i s t i n t h a t market, and p r o v i d i n g , where p o s s i b l e , explana-t i o n s f o r those p e c u l i a r i t i e s and i m p e r f e c t i o n s . Achievement of the f i r s t o f the above mentioned o b j e c t i v e s i n v o l v e s the development of models e x p l a i n i n g the behaviour of the three money market p a r t i c i p a n t s , the i n v e s -t o r , the borrower, and the investment d e a l e r . The b a s i c premise u n d e r l y i n g these models i s t h a t each p a r t i c i p a n t attempts to maximize h i s wealth s u b j e c t to c e r t a i n c o n s t r a i n t s A l s o i n v o l v e d i n o u t l i n i n g the o v e r a l l s e t t i n g i s a d i s c u s s i o n of the market's r o l e o f equating the supply of and demand f o r short-term c a p i t a l , a b r i e f sketch of i t s h i s t o r y , and example of the mechanisms i n v o l v e d i n i t s a c t u a l workings. The s e c u r i t i e s which comprise the market's stock i n trade are d i s c u s s e d i n a b s t r a c t terms with p a r t i c u l a r emphasis being p l a c e d on t h e i r l i q u i d i t y c h a r a c t e r i s t i c s and i n more concrete terms where the f o u r t e e n main instruments of the market are b r i e f l y d e s c r i b e d . The three remaining o b j e c t i v e s are achieved by drawing h e a v i l y upon i n f o r m a t i o n about the l o c a l market ob-t a i n e d d u r i n g i n t e r v i e w s w i t h f i f t e e n p a r t i c i p a n t s i n the Vancouver money market and i n t e r p r e t i n g t h i s i n f o r m a t i o n w i t h r e f e r e n c e to the b e h a v i o u r a l models which were d e v e l -oped. While the market has r e c e n t l y experienced r a p i d . u growth, i t continues to be dwarfed by the Toronto-Montreal market. I t i s concluded t h a t there are four main p e c u l i a r i -t i e s o r i m p e r f e c t i o n s i n the l o c a l market. The low l e v e l o f d e a l e r i n v e n t o r i e s of money market instruments, which bene-f i t s l o c a l borrowers but h i n d e r s the achievement of the i n -v e s t o r s ' g o a l s , r e s u l t s from the investment s t r a t e g y of d e a l e r s and such exogenous f a c t o r s as the c e n t r a l i z e d cash management by c h a r t e r e d banks and the l i m i t e d number of l o -c a l sources of non-bank f i n a n c i n g f o r i n v e n t o r i e s . Lack of l o c a l d e a l e r autonomy r e s u l t s from c e n t r a l i z e d d e c i s i o n making by investment d e a l e r s and the low l e v e l of l o c a l i n -v e n t o r i e s . T h i s l a c k of l o c a l autonomy and the time zone d i f f e r e n t i a l between the Vancouver market and the E a s t e r n market reduce the l i q u i d i t y of instruments i n the Vancouver market while the a t t r a c t i v e n e s s of the l o c a l l y - i s s u e d s e c u r i -t y i s enhanced by i t s ready a v a i l a b i l i t y . F i n a l l y , the l a c k of p a r t i c i p a n t s o p h i s t i c a t i o n , which i s an a t t r i b u t e o f the l o c a l market, i s regarded as being caused by l a c k of informa-t i o n and the r e s p o n s i b i l i t y f o r the p e r s i s t a n c e of t h i s t r a i t and f o r i t s f u t u r e e r a d i c a t i o n i s seen as r e s t i n g upon the i n -vestment d e a l e r . TABLE OF CONTENTS CHAPTER PAGE I INTRODUCTION 1 Statement of the Problem 1 Scope and Methodology of the Study 2 Pl a n o f T h e s i s 2 II THE CANADIAN MONEY MARKET: CONCEPTS AND FUNCTIONS 5 CONCEPTUALIZATION OF THE MONEY MARKET 5 MODELS OF PARTICIPANT BEHAVIOUR 9 P r o f i t a b i l i t y C r i t e r i a f o r Investment D e c i s i o n s 10 A B e h a v i o u r a l Model of the Money Market I n v e s t o r 20 A B e h a v i o u r a l Model o f the Money Market Borrower 2 5 A B e h a v i o u r a l Model of the Investment Dealer 30 A F u r t h e r Aspect of P a r t i c i p a n t I n t e r -a c t i o n 38 THE NATURE OF THE MARKET'S STOCK-IN-TRADE 4 0 T a n g i b l e A s s e t s Versus F i n a n c i a l A s s e t s 40 L i q u i d i t y 42 THE HISTORY OF THE MARKET AND ITS ROLE IN MONETARY POLICY 47 C r e a t i o n o f the Canadian Money Market 4 7 Monetary P o l i c y 48 FUNCTIONS OF THE MONEY MARKET: AN EXAMPLE 4 9 I I I CANADIAN MONEY MARKET INSTRUMENTS 55 THE STOCK IN TRADE OF MONEY MARKET DEALERS 57 Government of Canada Treasury B i l l s 57 Short-Term Canada and Canada Guaranteed Bonds 5 9 CHAPTER PAGE i P r o v i n c i a l S e c u r i t i e s 59 M u n i c i p a l Promissory Notes 61 Bankers' Acceptance 61 Bearer Deposit Term Notes 62 Other Chartered Bank Short-Term I n v e s t - 6 3 ment V e h i c l e s , T r u s t Company Deposits 63 and Loan and Mortgage Company S e c u r i t i e s 63 Acceptance and Finance Company Short-Term Promissory Notes 64 Prime Commercial Paper 66 Day-To-Day Loans to Investment Dealers 70 C o l l a t e r a l Loans or C a l l Loans 71 Repurchase Agreement or Buy-Backs 72 Summary 73 IV THE RECENTLY EVOLVED VANCOUVER MONEY MARKET AND ITS LOW LEVEL OF DEALER INVENTORIES 77 THE RECENT GROWTH OF THE VANCOUVER MONEY MARKET 78 DEALER INVENTORIES OF MONEY MARKET INSTRUMENTS IN VANCOUVER 86 F i n a n c i n g f o r Dealer I n v e n t o r i e s 90 Day-To-Day Loans 91 Other I m p l i c a t i o n s of the Day-Loan F a c t o r 94 C a l l Loans 96 Devices P r o v i d i n g A l t e r n a t i v e s t o Dealer Inventory 99 L e t t e r s of Undertaking 100 Issue of Notes by Agents 101 The Bank of Canada T r a n s f e r S e r v i c e 102 The P r o v i s i o n o f L o c a l l y - I s s u e d S e c u r i t i e s by Dealers on an Agency B a s i s 103 The I m p l i c a t i o n s o f Low Dealer Inventor-i e s f o r Vancouver I n v e s t o r s 104 The I m p l i c a t i o n s o f Low Dealer Inventor-i e s f o r Vancouver I s s u e r s 109 i v CHAPTER PAGE V ADDITIONAL PECULIARITIES OF THE VANCOUVER MONEY MARKET 111 DEALERS* LACK OF LOCAL AUTONOMY H I IMPLICATIONS OF TIME ZONE DIFFERENTIALS ' 115 THE LEVEL OF SOPHISTICATION EXHIBITED BY VANCOUVER INVESTORS AND BORROWERS 12 3 VI CONCLUSION 137 BIBLIOGRAPHY 144 APPENDIX A 147 APPENDIX B 159 APPENDIX C 180 LIST OF TABLES TABLE PAGE I VANCOUVER MONEY MARKET PARTICIPANTS INTERVIEWED FOR THIS STUDY 3 I I INSTRUMENTS TRADED IN THE CANADIAN MONEY MARKET 56 I I I MONEY MARKET JOBBERS 79 IV SOME LOCAL ISSUERS AND THEIR BORROWING LIMITS ON SHORT-TERM PROMISSORY NOTES 83 v i LIST OF FIGURES FIGURE PAGE 1 RELATIONSHIP OF CLAIMS 8 2 THE USE OF INDIFFERENCE CURVES FOR DETERMINING CERTAINTY EQUIVALENT VALUES 19 3 MARKETABILITY 4 4 4 THE RELATIONSHIP BETWEEN MARKETABILITY AND CAPITAL CERTAINTY 46 5 ADJUSTMENT OF BANK RESERVE POSITIONS THROUGH THE MONEY MARKET 53 6 NORTH AMERICAN TIME ZONES 117 v i i 1 CHAPTER I INTRODUCTION Th i s study, which i s an examination o f the Vancouver money market, was undertaken i n the b e l i e f t h a t i n s i g h t s i n t o the phenomenon which i s the Vancouver money market might be r e v e a l e d which would be of i n t e r e s t to both pres e n t and poten-t i a l p a r t i c i p a n t s i n t h a t market and to students o f f i n a n c i a l markets. Since f i n a n c i a l markets p l a y a c e n t r a l r o l e i n the f u n c t i o n i n g of c a p i t a l i s t economies, the Vancouver money mar-ket which i s a r e c e n t development i n the Canadian f i n a n c i a l market m e r i t s examination. I t i s hoped t h a t such an examina-t i o n w i l l c o n t r i b u t e to the understanding o f the Canadian ec-onomic mosaic and by d e s c r i b i n g the s t a t e of the a r t i n t h i s p a r t i c u l a r segment w i l l c o n t r i b u t e i n some way to i t s r e f i n e -ment . Statement of the Problem T h i s study has four o b j e c t i v e s . Those o b j e c t i v e s a r e : 1. To p r o v i d e a d e s c r i p t i o n of the o v e r a l l s e t t i n g i n which the Vancouver money market e x i s t s . 2. To d e s c r i b e the Vancouver money market. 3. To i n d i c a t e the major p e c u l i a r i t i e s and i m p e r f e c t i o n s which e x i s t i n t h a t market. 4. To p r o v i d e , where p o s s i b l e , e x p l a n a t i o n s f o r those pe-c u l i a r i t i e s and i m p e r f e c t i o n s . Scope and Methodology of the Study 2 The l i t e r a t u r e r e l a t e d to f i n a n c e and economics was surveyed and p r o v i d e d an overview of f i n a n c i a l markets i n gen-e r a l and was of s u b s t a n t i a l a s s i s t a n c e i n the development of the models of p a r t i c i p a n t behaviour. The l i t e r a t u r e f a i l e d to pr o v i d e any i n f o r m a t i o n about the management of d e a l e r s 1 i n -v e n t o r i e s of money market instruments. Moreover, the l i t e r a -t u r e on money markets has l i t t l e to say on the Vancouver money market which has o n l y r e c e n t l y m a t e r i a l i z e d . To o b t a i n i n -formation about the Vancouver money market, then, i t was nece-ss a r y to t u r n to primary sources. The p i c t u r e o f the Vancouver money market as i t emerges i n t h i s study stems from p e r s o n a l i n t e r v i e w s w i t h the per s o n n e l i n v o l v e d i n the money market oper-a t i o n s o f f i f t e e n l o c a l market p a r t i c i p a n t s . The p a r t i c i p a n t s are l i s t e d i n Table I. T h i s l i s t i s b e l i e v e d t o comprise a r e p r e s e n t a t i v e sample of l o c a l p a r t i c i p a n t s . P l a n o f T h e s i s T h i s t h e s i s i s d i v i d e d i n t o s i x c h a p t e r s , i n c l u d i n g an i n t r o d u c t o r y and a c o n c l u d i n g c h a p t e r , and three appendices. Chapter I I d i s c u s s e s the concepts r e l e v a n t t o the Canadian money market and the f u n c t i o n s o f t h a t market. Models of p a r t i c i p a n t behaviour are o u t l i n e d , the nature o f the a s s e t s traded i s d i s c u s s e d , the h i s t o r y of the Canadian money market and i t s r o l e i n monetary p o l i c y i s o u t l i n e d , and f i n a l l y , an 3 TABLE I VANCOUVER MONEY MARKET PARTICIPANTS INTERVIEWED FOR THIS STUDY Ames, E.A., & Co. L i m i t e d Bank of B r i t i s h Columbia Bank of Canada Bank of Nova S c o t i a B r i t i s h Columbia C e n t r a l C r e d i t Union B r i t i s h Columbia Packers L i m i t e d B r i t i s h Columbia Telephone Company Burns Bros. & Denton L i m i t e d Cominco L i m i t e d K e l l y Douglas & Company L i m i t e d MacMillan B l o e d e l L i m i t e d McLeod, Young, Weir & Co. L i m i t e d Wood Gundy S e c u r i t i e s L i m i t e d Woodward Stores L i m i t e d Y o r k s h i r e T r u s t Company 4 example i s presented of how the market f u n c t i o n s . Chapter I I I d e s c r i b e s the instruments i n v o l v e d i n the Canadian money market which are r e f e r r e d to i n Chapter II i n a more gen e r a l and a b s t r a c t manner. These instruments are ranked a c c o r d i n g to t h e i r major c h a r a c t e r i s t i c s o f r i s k , l i q u i d i t y , and y i e l d to m a t u r i t y . Chapters IV and V p r o v i d e a d e s c r i p t i o n of the Van-couver money market, o u t l i n e the major p e c u l i a r i t i e s and im-p e r f e c t i o n s of the market, and p r o v i d e e x p l a n a t i o n s f o r these m a n i f e s t a t i o n s where p o s s i b l e . Chapter IV o u t l i n e s the r e c e n t growth of the market and then d i s c u s s e s the low l e v e l s of d e a l e r i n v e n t o r i e s . Chapter V completes the main body of the t h e s i s by d i s c u s s i n g the l o c a l d e a l e r s ' l a c k of autonomy, p o i n t i n g out the i m p l i c a t i o n s of the East-West time zone d i f f e r e n t i a l , and f i n a l l y by examining the r e l a t i v e l a c k of l o c a l p a r t i c i p a n t s o p h i s t i c a t i o n . Chapter VI p r o v i d e s a summary of the study and suggests areas which warrant f u t u r e i n v e s t i g a t i o n . 5 CHAPTER I I THE CANADIAN MONEY MARKET: CONCEPTS AND FUNCTIONS T h i s Chapter p o r t r a y s the many f a c e t s o f the Canadian money market by d e s c r i b i n g i t s . p u r p o s e s and f u n c t i o n s , i t s p a r t i c i p a n t s and t h e i r i n t e r d e p e n d e n c i e s , and i t s economic importance and h i s t o r i c a l background. I. CONCEPTUALIZATION OF THE MONEY MARKET The money market i n Canada can be e n v i s i o n e d as a group o f buying and s e l l i n g i n s t i t u t i o n s , and middlemen who are i n communication w i t h one another by telephone, w i r e , and ma i l and who t r a n s a c t t h e i r o p e r a t i o n s through these media. The network o f communication media b r i n g s together (not i n a p h y s i c a l sense) those who p a r t i c i p a t e i n money market a c t i v i -t i e s which, i n essence, are comprised o f the issuance of and investment i n s h o r t - l i v e d f i n a n c i a l instruments. Canada's f i n a n c i a l market i s comprised o f two compo-nents: the money market and the c a p i t a l market."*" The d e l i n e -a t i o n i s dependent upon two aspects o f the f i n a n c i a l a s s e t E. Sh a p i r o , E. Solomon, and W. White, Money and  Banking (New York: H o l t , Rinehart and Winston,Inc., F i f t h E d i t i o n , 1968), p. 309. 6 i n v o l v e d ; whether i t i s debt or e q u i t y and i f debt, the time to m a t u r i t y . T r a n s a c t i o n s i n debt instruments w i t h a matur-i t y o f under t h r e e years are c l a s s i f i e d as money market t r a n s a c t i o n s while those i n v o l v i n g longer-term i s s u e s (both debt and e q u i t y ) are t r e a t e d as p a r t of the c a p i t a l market. By d e f i n i t i o n f i n a n c i a l a s s e t s and l i a b i l i t i e s o r i -g i n a t e only i n an a c t of borrowing and are reduced o n l y i n an a c t of debt repayment o r d e f a u l t . 1 Lending denotes the purchase of a newly c r e a t e d f i n a n c i a l a s s e t (which i s a l i a -b i l i t y t o the i s s u i n g u n i t ) while borrowing r e f e r s to the a c t of s e l l i n g a newly c r e a t e d f i n a n c i a l a s s e t (which, a g a i n , i s the l i a b i l i t y of the i s s u i n g u n i t ) . F i n a n c i a l a s s e t s (and f i n a n c i a l l i a b i l i t i e s c o n c u r r e n t l y ) o r i g i n a t e as the r e s u l t of the exchange t h a t takes p l a c e i n the a c t of l e n d i n g and borrowing. The terms lender and borrower g e n e r a l l y correspond w i t h the c l a s s i f i c a t i o n of economic u n i t s as s u r p l u s spenders 2 and d e f i c i t spenders o r , a l t e r n a t i v e l y , s a v i n g s - s u r p l u s u n i t s 3 and s a v i n g s - d e f i c i t u n i t s . A s u r p l u s u n i t i s one which spends l e s s than i t s c u r r e n t income f o r c u r r e n t output while a d e f i c i t u n i t spends more than i t s c u r r e n t income. A d e f i c i t u n i t can f i n a n c e i t s d e f i c i t by s e l l i n g a s s e t s but e v e n t u a l l y ''"Basil J . Moore, An I n t r o d u c t i o n to the Theory of F i -nance (New York: The Free P r e s s , 1968), p. 15. 2 I b i d . , p. 16. 3 James C. Van Home, F u n c t i o n and A n a l y s i s of C a p i t a l  Market Rates (Englewood C l i f f s , New J e r s e y : P r e n t i c e - H a l l , Inc., 1970), p. 2. 7 i t must r e s o r t to the c r e a t i o n of f i n a n c i a l a s s e t s which, when s o l d t o s u r p l u s u n i t s , become i t s l i a b i l i t y . A f i n a n c i a l i n -termediary i s a type o f economic u n i t which i s si m u l t a n e o u s l y a borrower and a lender and serves the f u n c t i o n o f matching the needs of s u r p l u s and d e f i c i t u n i t s . I t does so by i s s u i n g claims on i t s e l f to s u r p l u s u n i t s and pu r c h a s i n g the f i n a n c i a l c l a i m s on d e f i c i t u n i t s which may be of d i f f e r e n t terms and s i z e s compared to those i s s u e d by the f i n a n c i a l i n t e r m e d i a r y . I t can be seen from the f o r e g o i n g t h a t the r a i s o n d'etre of f i n a n c i a l markets i s the purchase and s a l e o f f i n a n -c i a l instruments to permit the d i s t r i b u t i o n of c u r r e n t expen-d i t u r e s among economic u n i t s to d i v e r g e from the d i s t r i b u t i o n of c u r r e n t income r e c e i v e d . ^ The d i s t r i b u t i o n of the owner-sh i p o f f i n a n c i a l a s s e t s and the u t i l i z a t i o n o f f i n a n c i a l l i a b i l i t i e s to f i n a n c e c u r r e n t expenditures among governments, households, business f i r m s and f i n a n c i a l i n s t i t u t i o n s i s shown g r a p h i c a l l y i n F i g u r e 1. The money market i n v o l v e s o n l y s h o r t - t e r m f i n a n c i a l instruments and i t f u n c t i o n s so as to equate the supply o f and demand f o r these. T h i s f u n c t i o n i s f a c i l i t a t e d by the i n t e r m e d i a t i n g r o l e of the investment d e a l e r whose o p e r a t i o n s are o u t l i n e d i n the Investment D e a l e r s ' A s s o c i a t i o n B r i e f to the Royal Commission on Banking and F i -2 nance. The money market can be seen as supplementing the ''"Moore, op. c i t . , p. 17. 2 Investment D e a l e r s ' A s s o c i a t i o n o f Canada, B r i e f to  the Royal Commission on Banking and Finan c e , June, 1962, Appendix G, p. 15. FIGURE I RELATIONSHIP OF. CLAIMS ffuS/VSZSS P/.1*IS Assort Source: James C. Van Home, F u n c t i o n and A n a l y s i s o f C a p i t a l Market Rates (Englewood C l i f f s , New J e r s e y : P r e n t i c e -H a l l , Inc., 1970), p. 9. 9 r o l e o f f i n a n c i a l i n t e r m e d i a r i e s i n e n a b l i n g i n d i v i d u a l s , b usinesses and other e n t i t i e s t o a l t e r the composition o f t h e i r p o r t f o l i o s o f a s s e t s and l i a b i l i t i e s and i t helps them t o s h i f t from s a v i n g i n some p e r i o d s to d i s s a v i n g i n o t h e r s . I I . MODELS OF PARTICIPANT BEHAVIOUR The c o n c e p t u a l i z a t i o n of the Canadian money market as a group of buying and s e l l i n g i n s t i t u t i o n s and middlemen can be f u r t h e r g e n e r a l i z e d by viewing the market as the i n -t e r a c t i o n between s u r p l u s u n i t s , d e f i c i t u n i t s , and middle-men. In t h i s study t h i s t r i o i s composed of le n d e r s or i n -v e s t o r s , borrowers or i s s u e r s , and investment d e a l e r s . (The i n t e r m e d i a t i n g or middleman f u n c t i o n s of the f i n a n c i a l i n s t i -t u t i o n s , although i n c o m p e t i t i o n w i t h the d e a l e r s , have been igno r e d s i n c e the term "money market" i n Canada g e n e r a l l y r e -f e r s to t h a t market f o r sho r t - t e r m funds i n which investment d e a l e r s , and e s p e c i a l l y the money market j o b b e r s , p l a y a c e n t r a l r o l e ) . While the d i s c u s s i o n to t h i s p o i n t has o u t l i n e d the concepts r e l a t e d t o the i n t e r a c t i o n o f these three types o f money market p a r t i c i p a n t s and the b a s i c economic f u n c t i o n s which t h i s i n t e r a c t i o n performs, i t i s necessary to make ex-p l i c i t the b a s i c b e h a v i o u r a l models which i n t h i s study are assumed to e x p l a i n the a c t i o n s o f these p a r t i c i p a n t s . In attempting to formulate models t o e x p l a i n behaviour, one must look f i r s t at the b a s i c o b j e c t i v e s o f those whose be-havio u r i s to be e x p l a i n e d . • For money market p a r t i c i p a n t s the b a s i c o b j e c t i v e which appears to be a t the r o o t o f t h e i r a c t i -v i t i e s i s the g o a l of maximizing wealth, although t h i s goal i s s u b j e c t to some c o n s t r a i n t s . The exte n t to which the goal of wealth maximization i s sought a f t e r depends upon the par-t i c i p a n t ' s degree of a v e r s i o n to r i s k - t a k i n g , the a v a i l a b i l i t y of o p p o r t u n i t i e s f o r investment, the a v a i l a b i l i t y o f funds f o r investment i n the a v a i l a b l e investment o p p o r t u n i t i e s , and, f i n a l l y , the c o n s t r a i n t s of e t h i c a l and l e g a l standards. I t i s assumed t h a t i n seeking to a t t a i n t h e i r g o a l o f wealth maximization, p a r t i c i p a n t s adopt s t r a t e g i e s which are formu-l a t e d u s i n g p r o f i t a b i l i t y c r i t e r i a f o r investment d e c i s i o n s . The assumption t h a t such c r i t e r i a form the bases f o r s t r a t e g y f o r m u l a t i o n by p a r t i c i p a n t s i s founded i n the b e l i e f t h a t i n a l l o c a t i n g funds among investment p r o j e c t s , each i s attempting t o i n c r e a s e h i s net worth so as to maximize wealth. The p r o f i -t a b i l i t y c r i t e r i a f o r investment d e c i s i o n s are o u t l i n e d below p r i o r t o the p r e s e n t a t i o n o f the p a r t i c i p a n t behaviour models i n which these c r i t e r i a p l a y c e n t r a l r o l e s . P r o f i t a b i l i t y C r i t e r i a f o r Investment D e c i s i o n s The c r i t e r i a assumed to form the bases f o r s t r a t e g y f o r m u l a t i o n by money market p a r t i c i p a n t s are the net present v a l u e c r i t e r i o n and the i n t e r n a l r a t e o f r e t u r n c r i t e r i o n . Both of these concepts are o u t l i n e d below: f i r s t , assuming t h a t a l l cash flows occur as p r e d i c t e d and subsequently, under c o n d i t i o n s of u n c e r t a i n t y . 1 The net p r e s e n t v a l u e (NPV) c r i t e r i o n s t a t e s t h a t to maximize i t s net p r e s e n t worth a f i r m should undertake a l l i n -vestment p r o j e c t s which have a net p r e s e n t value g r e a t e r than zero and r e j e c t a l l o t h e r s . An investment's c o n t r i b u t i o n to the f i r m ' s net p r e s e n t worth i s d e f i n e d as the net present v a l u e of the investment p r o j e c t ; t h a t i s , NPV = t=0 '(1+k) where a f c stands f o r the net cash flow at the end o f p e r i o d s 0, 1, 2,...,n (before any payments to c a p i t a l ) and k, the c o s t of c a p i t a l , i s a c o n s t a n t (the term c o s t of c a p i t a l be-i n g d e f i n e d as the p r i c e p a i d by a f i r m f o r funds a c q u i r e d 2 from i t s c a p i t a l s u p p l i e r s ) . The i n t e r n a l r a t e o f r e t u r n (IRR) c r i t e r i o n s t a t e s t h a t an investment should be accepted i f i t s i n t e r n a l r a t e o f r e t u r n i s above the f i r m ' s c o s t of c a p i t a l . I t r e q u i r e s t h a t investment p r o j e c t s be ranked a c c o r d i n g to t h e i r r e t u r n s and t h a t the c o s t of c a p i t a l serve as a c u t o f f p o i n t i n the f i r m ' s The d i s c u s s i o n of the net p r e s e n t value and i n t e r n a l r a t e of r e t u r n c r i t e r i a under c o n d i t i o n s of c e r t a i n t y r e l i e s h e a v i l y on the d i s c u s s i o n of these concepts by James C.T. Mao, Q u a n t i t a t i v e A n a l y s i s of F i n a n c i a l D e c i s i o n s (London: The Macmillan Company C o l l i e r - M a c m i l l a n L i m i t e d , 1969), pp.188-232. 2 I b i d . , p. 371. investment program. The i n t e r n a l r a t e of r e t u r n o f an i n v e s t -ment i s d e f i n e d as the r a t e of d i s c o u n t t h a t equates the p r e s -ent v a l u e of the e n t i r e s e r i e s o f cash flows a s s o c i a t e d w i t h the p r o j e c t to zero. When a f c r e p r e s e n t s the net cash flow a t the end of p e r i o d t , where t = 0, 1, 2,...,n, the p r o j e c t ' s IRR, r * , i s then d e f i n e d by t=0 ( l + r * ) t In the case where a Q < 0 and a t > 0 ( t = l , 2 , . . . , n ) , the above equation can be expressed as n ~ a 0 = E — t = 1 ( l + r * ) t The i n t e r n a l r a t e o f r e t u r n then becomes the r a t e o f d i s c o u n t t h a t equates the pr e s e n t value o f f u t u r e cash r e c e i p t s to the c o s t of the p r o j e c t . However, i f the cash expenditures of an investment are not r e s t r i c t e d to the i n i t i a l p e r i o d , the r e -t u r n may vary d i r e c t l y w i t h the c o s t of c a p i t a l to the f i r m . The i n t e r n a l r a t e o f r e t u r n and the p r o f i t a b i l i t y of an investment are not i d e n t i c a l . The i n t e r n a l r a t e of r e t u r n of an investment i s c a l c u l a t e d b e f o r e the d e d u c t i o n of the c o s t of funds u t i l i z e d and t h e r e f o r e the investment i s p r o f i t a b l e o n l y when i t s i n t e r n a l r a t e o f r e t u r n i s above the c o s t o f c a p i t a l to the f i r m . For the measurement of p r o f i t a b i l i t y the net present •value and i n t e r n a l r a t e of r e t u r n c r i t e r i a r e s u l t i n the same d e c i s i o n r e g a r d i n g acceptance or r e j e c t i o n f o r simple i n v e s t -ments. A simple investment i s one whose net cash flow takes the p a t t e r n of an i n i t i a l o u t l a y f o l l o w e d by cash r e c e i p t s alone. For nonsimple investments whose cash outflows are i n t e r s p e r s e d w i t h net cash i n f l o w s throughout the d u r a t i o n o f the investment, the i n t e r n a l r a t e of r e t u r n c r i t e r i o n may not p r o v i d e an unambiguous c r i t e r i o n f o r measuring p r o f i t a -b i l i t y . T h i s c r i t e r i o n may prove ambiguous s i n c e f o r non-simple investments there may not be a r a t e of r e t u r n concept independent of the c o s t of c a p i t a l to the f i r m and i n some cases a s i n g l e p r o j e c t may have m u l t i p l e i n t e r n a l r a t e s of r e t u r n . In the event t h a t a f i r m has l i m i t e d funds a v a i l -a b l e f o r investment and more p r o f i t a b l e o p p o r t u n i t i e s e x i s t f o r investment than can be accommodated, the f i r m then faces the problem of s e l e c t i n g an o p t i m a l p o r t f o l i o o f investments. To make such a s e l e c t i o n , a l l competing investments can be ranked i n d e c r e a s i n g order a c c o r d i n g to e i t h e r t h e i r i n t e r n a l r a t e s of r e t u r n or t h e i r net p r e s e n t v a l u e s . Investments are then accepted i n t h a t order u n t i l the c a p i t a l budget o f the f i r m i s exhausted. Under c o n d i t i o n s of c a p i t a l r a t i o n i n g the p r i n c i p l e of o p p o r t u n i t y c o s t r e q u i r e s t h a t the net pres e n t v a l u e of an investment be computed by d i s c o u n t i n g net cash flows a t the f i r m ' s marginal investment r e t u r n i n s t e a d of the f i r m ' s c o s t 14 o f c a p i t a l . T h i s i m p l i e s t h a t funds r e l e a s e d by the p r o j e c t can be r e i n v e s t e d at a r e t u r n equal to the f i r m ' s marginal investment r e t u r n . I f a common reinvestment r a t e i s assumed f o r p r o j e c t s o f d i f f e r i n g d u r a t i o n s , competing investments can be ranked c o r r e c t l y by u s i n g the net present value per u n i t of o u t l a y as a p r o f i t a b i l i t y index. The d i s c u s s i o n has, to t h i s p o i n t , assumed t h a t i n -vestment d e c i s i o n s are made under c o n d i t i o n s o f c e r t a i n t y which i m p l i e s t h a t the cash flows a s s o c i a t e d w i t h an i n v e s t -ment are not random v a r i a b l e s but f i x e d q u a n t i t i e s . The con-d i t i o n s o f u n c e r t a i n t y which e x i s t i n the r e a l world r e q u i r e t h a t c o n s i d e r a t i o n be g i v e n to the r i s k element o f investments. Such r i s k i s comprised of o p e r a t i n g r i s k and f i n a n c i a l r i s k . O p e r a t i n g r i s k i n h e r e n t i n an investment i s embodied i n the p o s s i b i l i t y t h a t a c t u a l cash flows w i l l d i f f e r from a n t i c i p a -t e d cash flows. F i n a n c i a l r i s k i s i n t r o d u c e d through the use of debt or p r e f e r r e d stock f i n a n c i n g o f the investment. The two accepted methods f o r i n c o r p o r a t i n g r i s k i n t o investment a n a l y s i s are the c o s t o f c a p i t a l method and the c e r t a i n t y - e q u i v a l e n t method.1 The p r o b a b i l i s t i c approach to investment a n a l y s i s based on the work of F r e d e r i c k S. H i l l i e r , "The D e r i v a t i o n o f P r o b a b i l i s t i c Information f o r the E v a l u a t i o n o f Risky I n v e s t -ments," Management Science IX ( A p r i l , 1963), pp.443-457 as o u t l i n e d i n Mao, op_. c i t . , pp. 271-280 and i n Van Home, F i -n a n c i a l Management and Policy,pp.131-147 i s r e j e c t e d as being u n s u i t a b l e . T h i s approach c e n t r e s around the expected value and standard d e v i a t i o n o f the p r o b a b i l i t y d i s t r i b u t i o n of the net p r e s e n t v a l u e of an investment. By d i s c o u n t i n g the ex-pected v a l u e o f the net cash flows by fehe r i s k - f r e e r a t e o f i n t e r e s t , the approach t r e a t s these expected cash flows as c e r t a i n which, s i n c e they are not c e r t a i n , r e p r e s e n t s a con-t r a d i c t i o n . Thus, the r e s u l t i n g expected value o f the prob-a b i l i t y d i s t r i b u t i o n o f net p r e s e n t value a r r i v e d at by t h i s approach appears to be l a c k i n g any economic s i g n i f i c a n c e . 15 Under the method of the c o s t of c a p i t a l as i t i s pre -sented by Mao,''"the net pr e s e n t value of an investment i s c a l c u l a t e d by d i s c o u n t i n g the expected cash flows at a r a t e t h a t allows f o r the time v a l u e of money and f o r the d i s -p e r s i o n p r e s e n t i n the cash flow d i s t r i b u t i o n . The i n v e s t -ment i s p r o f i t a b l e i f the r e s u l t i n g net presen t value i s g r e a t e r than zero. Cash flow here i s d e f i n e d as being ex-c l u s i v e of any payments to the s u p p l i e r s o f c a p i t a l . The d i s c o u n t r a t e i s the weighted average o f the c o s t s o f debt, p r e f e r r e d s t o c k , and common e q u i t y , u s i n g as weights t h e i r r e l a t i v e p r o p o r t i o n s i n the f i r m ' s t o t a l f i n a n c i n g mix. Since a change i n the f i r m ' s t o t a l f i n a n c i n g mix a f f e c t s the weighted average c o s t o f c a p i t a l , the use o f a constant weighted av-erage c o s t o f c a p i t a l as the d i s c o u n t r a t e assumes t h a t the f i r m w i l l f i n a n c e i n a p r o p o r t i o n a l manner over time. The e x c l u s i o n of any payments to c a p i t a l s u p p l i e r s from cash flows and the use of the weighted average c o s t o f c a p i t a l as the d i s -count r a t e have the e f f e c t o f making the investment d e c i s i o n separate from the d e c i s i o n o f how to f i n a n c e a p a r t i c u l a r p r o j e c t . Mao, op_. c i t . , p. 269. 2 The use of the weighted average c o s t of c a p i t a l as a d i s c o u n t r a t e presupposes t h a t the risk-premium embodied i n the c o s t o f common e q u i t y w i l l be unchanged i f the p r o j e c t under c o n s i d e r a t i o n i s accepted. T h i s assumption i s j u s t i -f i e d o n l y i f the p r o j e c t has the same degree of r i s k as the t y p i c a l e x i s t i n g investment. V a r y i n g the d i s c o u n t r a t e so t h a t the g r e a t e r the r i s k , the higher the d i s c o u n t r a t e i s an approach which r e c o g n i z e s t h a t s h a r e h o l d e r s ' r i s k - p r e m i a are r e l a t e d to the r i s k i n e s s of the f i r m ' s investments. The d i f f i c u l t y i n de-te r m i n i n g the a p p r o p r i a t e adjustment f o r a p a r t i c u l a r investment i n a Where each cash flow a^ _ a t the end of p e r i o d 0,1, ...,n i s a random v a r i a b l e with a mean of y t and a standard d e v i a t i o n of o*t and where k i s the a p p r o p r i a t e l y weighted c o s t of c a p i t a l , the net p r e s e n t value of an investment i s g i v e n by the f o l l o w i n g formula: n y t NPV = £ r t=0 (l+k) f c The a n a l y s i s may be extended to the i n t e r n a l r a t e of r e t u r n of an investment s i n c e the net p r e s e n t value of the proposed investment w i l l be p o s i t i v e i f and only i f the i n t e r n a l r a t e of r e t u r n exceeds the d i s c o u n t r a t e . The c e r t a i n t y - e q u i v a l e n t method f o r i n c o r p o r a t i n g r i s k i n t o investment a n a l y s i s i n v o l v e s the m o d i f i c a t i o n of the expected cash flows d i s c o u n t e d i n determining the net p r e s e n t v a l u e of an investment. The m o d i f i c a t i o n i s such t h a t the r e s u l t a n t amounts to be d i s c o u n t e d can be regarded by the i n v e s t o r as being c e r t a i n . S ince the m o d i f i e d cash flows can be t r e a t e d as c e r t a i n , the d i s c o u n t r a t e to be used i n c a l c u l a t i n g the net p r e s e n t value of the investment does not i n c l u d e a risk-premium. Inasmuch as the f i n a n c i a l l i a b i l i t i e s o f the f e d e r a l government are regarded as being i f r e e from the r i s k of d e f a u l t which means t h a t the i n t e r e s t payments and p r i n c i p a l repayments comprising the cash flows c o n s i s t e n t and o b j e c t i v e manner i s the main c r i t i c i s m of the approach c i t e d by James C. Van Home, F i n a n c i a l Management  and P o l i c y , Second E d i t i o n (Englewood C l i f f s , New J e r s e y : P r e n t i c e - H a l l , Inc., 1971), p. 126. a s s o c i a t e d with such l i a b i l i t i e s are amounts known with c e r -t a i n t y , the i n t e r e s t r a t e of f i n a n c i a l l i a b i l i t i e s o f the f e d e r a l government i n c l u d e s no risk-premium. The r a t e of i n t e r e s t on f e d e r a l s e c u r i t i e s i s t h e r e f o r e regarded as the r i s k - f r e e r a t e of i n t e r e s t and i s the a p p r o p r i a t e d i s c o u n t r a t e t o be used i n c a l c u l a t i n g the net p r e s e n t value of an investment under the c e r t a i n t y - e q u i v a l e n t method. In the d i s c u s s i o n which f o l l o w s the s i m p l i f y i n g assumption i s made t h a t the r i s k - f r e e r a t e of i n t e r e s t i s constant. For such a s i t u a t i o n to occur would r e q u i r e t h a t the same i n t e r e s t r a t e would e x i s t f o r a l l m a t u r i t i e s f o r a l l government s e c u r i t i e s . In r e a l i t y , the d i s c o u n t r a t e used f o r each p e r i o d would be the i n t e r e s t r a t e of a government s e c u r i t y maturing i n the corresponding p e r i o d . T h e r e f o r e , the y i e l d on a Government of Canada t r e a s u r y b i l l or bond maturing i n f o u r t e e n days would be the a p p r o p r i a t e r a t e to use i n d i s c o u n t i n g a c e r t a i n cash flow which i t i s b e l i e v e d w i l l occur two weeks i n the f u t u r e while the y i e l d on a Government of Canada bond matur-i n g i n two years would be s u i t a b l e f o r a c e r t a i n cash flow expected i n two y e a r s . Where the net cash flow, a f c, a t the end of p e r i o d t (t = 0,1,...,n) i s a random v a r i a b l e w i t h a mean of where i i s the r i s k - f r e e r a t e of i n t e r e s t and i s assumed to be c o n s t a n t , and where i s the c e r t a i n t y - e q u i v a l e n t coe^f f f i c i e n t , the investment i s p r o f i t a b l e i f the net p r e s e n t value i n the f o l l o w i n g equation i s p o s i t i v e ; n a t y t NPV = S _ t=0 ( l + i ) t The c e r t a i n t y - e q u i v a l e n t c o e f f i c i e n t , i s a val u e between 0 and 1.00 which v a r i e s i n v e r s e l y w i t h the degree o f r i s k and i s determined by the i n v e s t o r ' s u t i l i t y p r e f e r e n c e s w i t h r e s p e c t to r i s k . When the c o e f f i c i e n t i s m u l t i p l i e d by the expected cash flow, the product would be regarded by the i n v e s t o r as e q u a l l y d e s i r a b l e t o a c e r t a i n cash flow."'" That i s , a = A t = C e r t a i n Cash Flow Risky Cash Flow In e f f e c t the i n v e s t o r i s simply s a y i n g t h a t he would be i n -d i f f e r e n t i n p e r i o d t between a^.y^ equal to A^ _, an amount known with c e r t a i n t y , and the expected but u n c e r t a i n amount, y^. F i g u r e 2 shows a s e r i e s o f i n d i f f e r e n c e curves between c e r t a i n r e t u r n s and p r o g r e s s i v e l y more r i s k y expected r e t u r n s such t h a t A^ i s e q u i v a l e n t to y^. The f a c t o r s which determine the r i s k i n e s s of an investment to an i n v e s t o r a r e : the d i s -p e r s i o n of the s u b j e c t i v e p r o b a b i l i t y d i s t r i b u t i o n assigned t o the p o s s i b l e cash flo w s , the form of t h i s d i s t r i b u t i o n , and the extent t o which random v a r i a t i o n s i n the cash flows are c o r r e l a t e d w i t h the v a r i a t i o n s i n the cash flows o f other i n -vestments. The l a r g e r the c e r t a i n - e q u i v a l e n t c o e f f i c i e n t , the lower the d i s p e r s i o n , the more a t t r a c t i v e to the i n v e s t o r the form o f the d i s t r i b u t i o n , and the more random v a r i a t i o n s "*"Van Home, F i n a n c i a l Management, p. 12 7. 19 FIGURE 2 THE USE OF INDIFFERENCE CURVES FOR DETERMINING CERTAINTY EQUIVALENT VALUES A and P t INDIFFERENCE CURVES Risk i n cash flows tend t o c a n c e l out wit h the v a r i a t i o n s i n the cash flows of other investments undertaken.''" I t should be noted t h a t , u n l i k e the c o s t of c a p i t a l approach, under the c e r t a i n t y - e q u i v a l e n t approach the net cash flows are a f f e c t e d by f i n a n c i n g c o s t s . The cash flows would be net of' r i s k premia which are r e f l e c t e d i n f i n a n c i n g c o s t s . Adjustments f o r these premia should be i n c l u d e d i n the c e r t a i n t y - e q u i v a l e n t c o e f f i c i e n t , a^. T h i s concludes the d i s c u s s i o n o f the p r o f i t a b i l i t y c r i t e r i a f o r investment d e c i s i o n s under c o n d i t i o n s o f c e r -t a i n t y and u n c e r t a i n t y . The models which have been presented w i l l be used t o d i s c u s s the bases f o r s t r a t e g y f o r m u l a t i o n by money market p a r t i c i p a n t s . A B e h a v i o u r a l Model of the Money Market In v e s t o r The assumption t h a t p r o f i t a b i l i t y c r i t e r i a f o r i n -vestment d e c i s i o n s p r o v i d e the bases f o r the s t r a t e g y of money market p a r t i c i p a n t s w i l l be most r e a d i l y granted i n the case of the money market i n v e s t o r . T h i s p a r t i c i p a n t exchanges funds f o r income-earning f i n a n c i a l a s s e t s . Such investment income i s u s u a l l y o n l y a supplementary source o f income. Un-l i k e an investment i n many types o f p h y s i c a l a s s e t s , an i n v e s t -ment i n f i n a n c i a l a s s e t s g e n e r a l l y i n v o l v e s a cash outflow Alexander A. Robichek and Stewart C. Myers, Optimal  F i n a n c i n g D e c i s i o n s (Englewood C l i f f s , New J e r s e y : P r e n t i c e -H a l l Inc.,. 1965), pp. 79-81. 21 i n o n l y the i n i t i a l p e r i o d w i t h subsequent cash flows being i n f l o w s . Investment i n f i n a n c i a l a s s e t s i s t y p i c a l l y simple investment as the e x p r e s s i o n i s used i n the p r e v i o u s d i s c u s s i o n of p r o f i t a b i l i t y c r i t e r i a . net p r e s e n t worth under c o n d i t i o n s of u n c e r t a i n t y , the b a s i c b e h a v i o u r a l model which i s assumed i n t h i s study to determine the i n v e s t o r ' s behaviour can be s t a t e d as f o l l o w s : an i n v e s t o r attempts to maximize the net p r e s e n t value of the net cash flows a s s o c i a t e d with an investment as c a l c u l a t e d under the c e r t a i n t y e q u i v a l e n t approach. That i s , where i i s the r i s k -f r e e r a t e of i n t e r e s t and a^_, the net cash flow a s s o c i a t e d w i t h the investment a t the end of p e r i o d t ( t = 0,1,...n), i s a random v a r i a b l e w i t h a mean of V^ . and a ^ i s the c e r t a i n t y -e q u i v a l e n t c o e f f i c i e n t , the i n v e s t o r ' s aim i s to maximize the net p r e s e n t value as d e p i c t e d by the f o l l o w i n g formula: The i n v e s t o r ' s aim can be rephrased as seeking t h a t investment o p p o r t u n i t y which o f f e r s the h i g h e s t net p r e s e n t value f o r any planned o u t l a y . 1 The investment d e c i s i o n r u l e as s t a t e d i n the p r e v i o u s s e c t i o n o u t l i n i n g the p r o f i t a b i l i t y c r i t e r i a f o r Presumably the more NPV per $1 of o u t l a y t h a t can be o b t a i n e d , the more i n t e r e s t an i n v e s t o r would have i n r e -ducing f u r t h e r h i s cash balances i n favour of money market i n -struments. In t h i s c o n n e c t i o n a p r o f i t a b i l i t y index such as NPV/OUTLAY might be u s e f u l t o r e f l e c t the p o s s i b l e e x i s t e n c e of e l a s t i c i t y o f investment o u t l a y s w i t h r e s p e c t to NPV per $1 of o u t l a y . Since the i n v e s t o r i s attempting to maximize h i s NPV = I t=0 n investment d e c i s i o n s demands t h a t o n l y investments w i t h a p o s i t i v e net prese n t v a l u e be accepted. T h i s d e c i s i o n r u l e i s m o d i f i e d i n the case o f the money market i n v e s t o r who i t i s assumed i s faced w i t h the a l t e r n a t i v e s of i n v e s t i n g i n a money market instrument or i n cash which has a n e g a t i v e net pr e s e n t value s i n c e i t n e i t h e r a p p r e c i a t e s nor earns i n t e r e s t . There-f o r e , s i n c e money market investments w i t h a net p r e s e n t value g r e a t e r than the ne g a t i v e net pr e s e n t value of an equal i n v e s t -ment i n cash w i l l be regarded as being c e r t a i n t o i n c r e a s e the i n v e s t o r ' s wealth, a l l o t h e r s w i l l be r e j e c t e d . As a r e s u l t o f t h i s m o d i f i c a t i o n of the investment d e c i s i o n r u l e , a money market investment may have a n e g a t i v e net present v a l u e . In the case o f the money market i n v e s t o r , s i n c e the funds u t i l i z e d are u l t i m a t e l y intended f o r other purposes and s i n c e the c o s t o f such funds i s to be borne by the p r o j e c t f o r which they were e i t h e r r e t a i n e d or ob t a i n e d , the money market investment should not be expected to bear any of the c o s t s of such funds. The cash flows a s s o c i a t e d w i t h a money market i n -vestment t y p i c a l l y i n v o l v e an o u t l a y of funds by the i n v e s t o r i n the i n i t i a l p e r i o d f o l l o w e d by net cash r e c e i p t s i n subse-quent p e r i o d s . Included i n the o u t l a y are the a c t u a l purchase p r i c e of the s e c u r i t y , any i n f o r m a t i o n c o s t s i n c u r r e d to A l t e r n a t i v e l y , the i n v e s t o r may see the money market investment and the p r o j e c t as one investment. 23 determine the c r e d i t worthiness of the i s s u e r , and any t r a n s -a c t i o n c o s t s a s s o c i a t e d w i t h the purchase such as d e a l e r commi-s s i o n s or t r a n s f e r fees ( u s u a l l y no such charges are i n v o l v e d i n money market p u r c h a s e s ) . Net cash r e c e i p t s are comprised of p r i n c i p a l repayments and i n t e r e s t r e c e i v e d l e s s any informa-t i o n c o s t s i n c u r r e d to monitor the c r e d i t worthiness of the i s s u e r , and any t r a n s a c t i o n c o s t s i n c u r r e d when the investment i s t erminated. ( U s u a l l y no such charges are i n v o l v e d i f the investment i s s o l d b e f o r e m a t u r i t y , such s a l e s being on a net b a s i s , and none i s i n v o l v e d i f the s e c u r i t y i s h e l d to m a t u r i t y ) . Where the p o s s i b i l i t y e x i s t s t h a t an investment may be terminated sooner than a n t i c i p a t e d , the degree of l i q u i d i t y possessed by the instrument must be c o n s i d e r e d by the i n v e s t o r . By d e f i n i t i o n a h i g h l y l i q u i d s e c u r i t y has a hig h p r o b a b i l i t y t h a t a high p r o p o r t i o n o f the pr e s e n t market value can be ob-t a i n e d on s h o r t notice."'" Under the c e r t a i n t y - e q u i v a l e n t approach the c a l c u l a t i o n of the net pr e s e n t value of a h i g h l y l i q u i d se-c u r i t y would not r e q u i r e a r e d u c t i o n o f the c e r t a i n t y - e q u i v a l e n t c o e f f i c i e n t to al l o w f o r the r i s k s embodied i n low l i q u i d i t y . Lack of l i q u i d i t y can i n c r e a s e the r i s k i n e s s of an investment by widening the d i s p e r s i o n o f the s u b j e c t i v e p r o b a b i l i t y d i s t r i -b u t i o n assigned to the p o s s i b l e cash flows and by a f f e c t i n g the form of t h i s d i s t r i b u t i o n i n a manner deemed u n d e s i r a b l e by the The concept of l i q u i d i t y i s d i s c u s s e d i n d e t a i l i n P a r t I I I of t h i s chapter. 24 i n v e s t o r . The two c h a r a c t e r i s t i c s of an a s s e t which stand out as the most important aspects of the l i q u i d i t y of an a s s e t are m a r k e t a b i l i t y and c a p i t a l c e r t a i n t y . M a r k e t a b i l i t y r e f e r s to the p r o p o r t i o n o f i t s p r e s e n t market value t h a t can be r e a l i z e d i n cash a t d i f f e r e n t time i n t e r v a l s a f t e r the d e c i -s i o n to s e l l w h i l e c a p i t a l c e r t a i n t y r e f e r s to the p r e d i c t a b i -l i t y w i t h which i t s expected market value at f u t u r e dates i s a n t i c i p a t e d . Both m a r k e t a b i l i t y and c a p i t a l c e r t a i n t y o f an a s s e t can a f f e c t the d i s p e r s i o n and form of the s u b j e c t i v e p r o b a b i l i t y d i s t r i b u t i o n a s s i g n e d to the p o s s i b l e cash f l o w s . The c e r t a i n t y - e q u i v a l e n t c o e f f i c i e n t : w i l l vary d i r e c t l y w i t h the p r o p o r t i o n of the pr e s e n t market value of the a s s e t t h a t can be r e a l i z e d immediately and wi t h the r a t e a t which t h a t p r o p o r t i o n approaches u n i t y . With lower c a p i t a l c e r t a i n t y the amount which can be r e a l i z e d from the f u t u r e s a l e o f an a s s e t becomes l e s s p r e d i c t a b l e and t h e r e f o r e the c e r t a i n t y -e q u i v a l e n t c o e f f i c i e n t v a r i e s d i r e c t l y w i t h the c a p i t a l c e r -t a i n t y of an a s s e t . A lower l e v e l o f l i q u i d i t y r e s u l t s i n a lower c e r t a i n t y - e q u i v a l e n t c o e f f i c i e n t to a d j u s t the expected net cash i n f l o w s to a lower l e v e l o f c e r t a i n cash flows and t h i s r e s u l t s i n a lower net p r e s e n t value o f the investment. The g r e a t e r the p r o b a b i l i t y t h a t an investment w i l l be termina-ted sooner than a n t i c i p a t e d , the g r e a t e r the l e v e l o f l i q u i d i t y possessed by s e c u r i t i e s t h a t w i l l be r e q u i r e d by a money market i n v e s t o r o r the lower the c e r t a i n t y - e q u i v a l e n t c o e f f i c i e n t , a t . I f the p r o b a b i l i t y of an e a r l y t e r m i n a t i o n of the investment i s zero, the c o e f f i c i e n t w i l l not be a f f e c t e d by the l i q u i d i t y c h a r a c t e r i s t i c s o f a s e c u r i t y . In summary, the money market i n v e s t o r i s h e r e i n assumed t o seek the maximum net pr e s e n t value per u n i t o f out-l a y o f the cash flows a s s o c i a t e d w i t h an investment which are regarded as being c e r t a i n as c a l c u l a t e d under the c e r t a i n t y -e q u i v a l e n t approach. A B e h a v i o u r a l Model of the Money Market Borrower The money market o p e r a t i o n s of the borrower can a l s o be analyzed i n terms of p r o f i t a b i l i t y c r i t e r i a f o r investment d e c i s i o n s . The market p r o v i d e s a means of f i n a n c i n g the i n -vestment p r o j e c t s o f the borrower and the c o s t o f such f i n a n -c i n g a f f e c t s the p r o f i t a b i l i t y o f the p r o j e c t s undertaken. Whether the borrower uses the net pr e s e n t value c r i t e r i o n or the i n t e r n a l r a t e of r e t u r n c r i t e r i o n does not a l t e r the f a c t t h a t the p r o f i t a b i l i t y o f an investment v a r i e s i n v e r s e l y with the c o s t of f i n a n c i n g such p r o j e c t s . Furthermore, the r i s k premia a s s o c i a t e d w i t h such c o s t s are allowed to reduce cash flows under the c e r t a i n t y e q u i v a l e n t approach and a l l such c o s t s are so i n c o r p o r a t e d i n the c o s t of c a p i t a l and do not a f f e c t net cash flows i n the c o s t of c a p i t a l approach. The c o s t o f c a p i t a l has been d e f i n e d p r e v i o u s l y as the p r i c e p a i d by a f i r m f o r funds a c q u i r e d from i t s c a p i t a l s u p p l i e r s . O b t a i n i n g s h o r t - t e r m funds from the money market. s u p p l i e r s i n v o l v e s expenses which may be regarded as the c o s t of s h o r t - t e r m c a p i t a l . In the c o s t o f c a p i t a l approach to i n -vestment e v a l u a t i o n , the c o s t of short-term c a p i t a l would be i n c o r p o r a t e d i n t o the f i r m ' s t o t a l c o s t of c a p i t a l i n propor-t i o n to the share of t o t a l f i n a n c i n g d e r i v e d from shor t - t e r m borrowing. I t should a l s o be noted t h a t although short-term borrowing appears on a balance sheet i n the c u r r e n t l i a b i l i t i e s s e c t i o n , many fi r m s c o n t i n u a l l y have such l i a b i l i t i e s o u t s t a n -d i n g and regard them as a permanent p a r t of the c a p i t a l s t r u c t u r e . Borrowing i n the money market as an a l t e r n a t i v e to bank borrowing o r i s s u i n g long-term debt may have an adverse e f f e c t on the t o t a l c o s t of c a p i t a l . The evidence a v a i l a b l e i n d i c a t e s t h a t a high e r risk-premium i s r e q u i r e d by i n v e s t o r s f o r s h o r t - t e r m instruments due to the " c r i s i s - a t - m a t u r i t y " prob-lem."'" T h i s problem a r i s e s because r e f i n a n c i n g and meeting the f i n a l redemption payment may c r e a t e f i n a n c i a l c r i s e s and make s h o r t m a t u r i t i e s r i s k i e r than long m a t u r i t i e s . T h e r e f o r e , i t i s l o g i c a l to assume t h a t the g r e a t e r the p r o p o r t i o n o f a f i r m ' s debt which i s i n s h o r t m a t u r i t i e s , the s m a l l e r the debt-e q u i t y r a t i o a c c e p t a b l e to both share-holders and long-term debt-h o l d e r s . The r i s k - p r e m i a demanded by these i n v e s t o r s may i n f a c t be i n c r e a s e d s u f f i c i e n t l y to r a i s e the c o s t s of e q u i t y and long-term debt t o the extent t h a t they may more than o f f s e t the savings achieved by i s s u i n g s h o r t - t e r m instruments and t h e r e -f o r e , r a i s e the f i r m ' s c o s t o f c a p i t a l . Van Home, F u n c t i o n and A n a l y s i s , pp. 116-118. Assuming t h a t the borrower attempts to maximize i n -vestment p r o f i t a b i l i t y , the g o a l of m i n i m i z i n g the c o s t of s h o r t - t e r m c a p i t a l p r o v i d e s the b a s i s f o r the borrower's money market a c t i v i t i e s . The c o s t . o f s h o r t - t e r m c a p i t a l may be viewed as t h a t d i s c o u n t r a t e which equates the net p r e s e n t v a l u e of payments to the s u p p l i e r s of such funds to the pro-ceeds r e c e i v e d by the borrower. That i s , where k g i s the c o s t of s h o r t - t e r m c a p i t a l , the borrower attempts to minimize k g i n the f o l l o w i n g e q u a t i o n : Proceeds to Borrower = £ Payments by Borrower t = l ( 1 + k s ) The proceeds to the borrower are comprised of the gross amount r e c e i v e d f o r the instrument i s s u e d l e s s the f o l l o w i n g : any commissions charged by the investment d e a l e r h a n d l i n g the t r a n s a c t i o n , the c o s t s i n c u r r e d i n drawing up and i s s u i n g the instrument or charges by an agent i s s u i n g the i n -strument, and expenses i n v o l v e d i n p r o v i d i n g i n f o r m a t i o n to d e a l e r s and l e n d e r s . The payments by the borrowers which are d i s c o u n t e d by the c o s t of s h o r t - t e r m c a p i t a l are i n t e r e s t pay-ments which occur d u r i n g the l i f e of the instrument and/or at i t s m a t u r i t y date and repayment of p r i n c i p a l which occurs at the m a t u r i t y d a t e . 1 "''An example ( i n which taxes are ignored) i s shown here of the c a l c u l a t i o n of the c o s t of short-term c a p i t a l . A 10% i n t e r -e s t - b e a r i n g instrument maturing i n two p e r i o d s having a face v a l u e of $100,000 i s s o l d a t par. Commission charges of 1/4 o f 1% t o t a l l i n g $250 are borne by the i s s u e r who a l s o i n c u r s i s s u -i n g expenses of $10 0 and i n f o r m a t i o n p r o v i d e d to the d e a l e r and i n v e s t o r c o s t s $100. Net proceeds to the i s s u e r t o t a l $99,550. 28 The f o l l o w i n g a l l have the e f f e c t of lowering k g , the c o s t of s h o r t - t e r m c a p i t a l : 1. An i n c r e a s e of the proceeds to the borrower, g i v e n the schedule and l e v e l of payments. 2. A decrease i n i n t e r e s t payments, given the amount of proceeds and the amount and t i m i n g o f p r i n c i p a l repay-ment and the t i m i n g " o f i n t e r e s t payments. 3. A decrease i n p r i n c i p a l repayment, g i v e n the t i m i n g of payments and the amounts of i n t e r e s t payments and pro-ceeds . 4. An i n c r e a s e or l e n g t h e n i n g of the payments schedule, g i v e n the amount o f payments and the l e v e l of proceeds. Both the c r e d i t worthiness of the borrower and the l i q u i d i t y of the instruments he i s s u e s w i l l a f f e c t the c o s t of short-term c a p i t a l to the borrower. I n v e s t o r s can not be ex-pected to e x h i b i t much i n t e r e s t i n an instrument i s s u e d by a borrower w i t h a poor c r e d i t r a t i n g or i f the instrument possesses l i t t l e or no l i q u i d i t y . I n v e s t o r s can be expected t o e x h i b i t more i n t e r e s t i n an instrument under e i t h e r o f these circumstances The c o s t of s h o r t - t e r m c a p i t a l to the i s s u e r of approximately 10.3% i s found by s o l v i n g the f o l l o w i n g e q u a t i o n : $99,550 = $10,000 + $110,000 I t can be seen from the above t h a t the proceeds to the i s s u e r being lower than the gross amount r e a l i z e d from the i s s u e r e -s u l t s i n a higher c o s t of s h o r t - t e r m c a p i t a l . Had the net pro-ceeds to the i s s u e r been the f u l l $100,000, k g would have been 10% which i s the nominal i n t e r e s t r a t e of the s e c u r i t y . i f the i n t e r e s t payments are i n c r e a s e d g i v e n t h a t the v a r i a n c e of expected r e t u r n s i s unchanged. Higher i n t e r e s t payments would then i n c r e a s e the l e v e l o f expected r e t u r n s and the se-c u r i t y ' s net pr e s e n t v a l u e . Higher c o s t s of short - t e r m c a p i t a l would r e s u l t from the higher i n t e r e s t payments made by the bor-rower to i n c r e a s e the a t t r a c t i v e n e s s o f h i s s e c u r i t y . In the event t h a t the instruments possess low l e v e l s of l i q u i d i t y but are otherwise a c c e p t a b l e to an i n v e s t o r , the i n v e s t o r may demand t h a t the borrower p r o v i d e an a l t e r n a t i v e to the l i m i t e d demand e x i s t i n g i n secondary markets f o r the instruments. That i s , the i n v e s t o r may r e q u i r e the o p t i o n of a c a l l p r i v i l e g e a l l o w i n g him to present the instruments to the borrower f o r p r i n c i p a l repayment before the m a t u r i t y date. The c a l l p r i v i l e g e overcomes the problem of l i m i t e d l i q u i d i t y o n l y i f the borrower i s ab l e to honour the request f o r e a r l y repayment. I f the borrower's c r e d i t s t a n d i n g i s such t h a t e a r l y repayment i s u n l i k e l y to prove d i f f i c u l t , the c a l l p r i v i -l ege v i r t u a l l y assures the i n v e s t o r o f being able to terminate h i s investment p r i o r to the m a t u r i t y date of the instruments i n -v o l v e d . To overcome the i n c r e a s e d c o s t such a c o n t r a c t i o n o f the payment schedule i n v o l v e s , the borrower may agree to the c a l l p r i v i l e g e on the c o n d i t i o n t h a t i n t e r e s t payments w i l l be reduced i f the o p t i o n i s e x e r c i s e d . The f i n a n c i a l and o p e r a t i n g r i s k s i n v o l v e d i n the p r o j e c t b e ing undertaken by the borrower are not i n c o r p o r a t e d i n t o the b e h a v i o u r a l model presented above but r a t h e r , are i n -clu d e d i n the p a r t i c u l a r c r i t e r i o n u t i l i z e d by the borrower to 30 e v a l u a t e the p r o f i t a b i l i t y of the p r o j e c t . M i n i m i z a t i o n o f the c o s t o f short- t e r m c a p i t a l as d e s c r i b e d by the model i s c o n s i s t e n t w i t h p r o f i t a b i l i t y c r i t e r i a f o r investment d e c i s i o n s and i s assumed i n t h i s study to pro v i d e an e x p l a n a t i o n of the behaviour of borrowers p a r t i c i p a t i n g i n money market a c t i v i t i e s . A B e h a v i o u r a l Model of the Investment Dealer In f u l f i l l i n g the r o l e o f middleman or i n t e r m e d i a t o r between the lend e r s and borrowers u t i l i z i n g the money market, the investment d e a l e r a l l o c a t e s r e s o u r c e s to the performance of t h i s f u n c t i o n i n a n t i c i p a t i o n of making a p r o f i t . The a l l o -c a t i o n o f re s o u r c e s by the d e a l e r r e p r e s e n t s an investment on h i s p a r t . T h i s allows the d e a l e r behaviour model to be based on the p r o f i t a b i l i t y c r i t e r i o n f o r investment d e c i s i o n s which i s assumed to determine the d e a l e r ' s s t r a t e g i c a c t i o n s . In c a r r y i n g out money market o p e r a t i o n s , a d e a l e r a c t s as an agent i n some t r a n s a c t i o n s and as a p r i n c i p a l i n o t h e r s . When p o s s e s s i o n of the instrument i n v o l v e d passes d i r e c t l y from the i s s u e r to the i n v e s t o r , the d e a l e r i s a c t i n g as an agent. In such a case the d e a l e r responds t o an i n v e s t o r ' s request f o r an investment o p p o r t u n i t y by l o c a t i n g an i s s u e r who w i l l supply an ac c e p t a b l e instrument to the i n v e s t o r . A l t e r -n a t i v e l y , the d e a l e r may be responding to an i s s u e r ' s request f o r funds by l o c a t i n g an i n v e s t o r who regards the instrument as s u i t a b l e f o r h i s investment needs. In any event the d e a l e r does not take t i t l e to the s e c u r i t y but merely a c t s as an agent i n matching the i s s u e r ' s and i n v e s t o r ' s needs. In ren -d e r i n g t h i s s e r v i c e the d e a l e r i n c u r s expenses i n v o l v e d i n the search f o r p a r t i c i p a n t s with matching needs, i n o b t a i n i n g data concerning the i s s u e r ' s c r e d i t w o rthiness, and i n the t r a n s m i s s i o n of these data t o the i n v e s t o r . Cash i n f l o w s t o the d e a l e r r e s u l t i n g from such t r a n s a c t i o n s are mainly com-p r i s e d o f commissions of from 1/8 to 1/4 of 1% per annum o f the par va l u e of the instruments i n v o l v e d . Such commission charges are l e v i e d o n l y on the i s s u e r of the s e c u r i t y w i t h none being l e v i e d on the i n v e s t o r . Other l e s s e a s i l y q u a n t i -f i a b l e b e n e f i t s to the d e a l e r r e s u l t i n g from good customer r e -l a t i o n s e s t a b l i s h e d through money market o p e r a t i o n s are the f e e s , s e r v i c e charges, and commissions f o r other d e a l e r s e r -v i c e s r a n g i n g from p o r t f o l i o management to u n d e r w r i t i n g which money market p a r t i c i p a n t s may u t i l i z e . To perform money market o p e r a t i o n s on an agency b a s i s the d e a l e r must a l l o c a t e r e s o u r c e s to t h a t f u n c t i o n i n the form of personnel and f a c i l i t i e s . I t should be noted t h a t such a l l o c a t i o n , which r e p r e s e n t s an investment i n money mar-ket o p e r a t i o n s by the d e a l e r , i s one which i s e a s i l y r e v e r s e d . That i s , such personnel and f a c i l i t i e s are g e n e r a l l y q u i t e e a s i l y adapted to other d e a l e r a c t i v i t i e s i n the event t h a t money market o p e r a t i o n s prove u n p r o f i t a b l e . The model assumed to e x p l a i n the behaviour of the d e a l e r a c t i n g as an agent can be s t a t e d as f o l l o w s : the d e a l e r attempts t o maximize the net pre s e n t value of the expected cash flows a s s o c i a t e d with money market o p e r a t i o n s d i s c o u n t e d by the d e a l e r ' s c o s t o f c a p i t a l . Where k i s the d e a l e r ' s c o s t of c a p i t a l , and the cash flow a t at the end of p e r i o d t ( t = 0,1,...,n) i s a random v a r i a b l e with mean and standard d e v i a t i o n , the d e a l e r attempts to maximize NPV i n the f o l l o w i n g e q u a t i o n : n y NPV = S — — t = 0 (1+k) * Assuming the c o s t of c a p i t a l t o be g i v e n , the d e a l e r attempts to maximize the net pr e s e n t value by: 1. A l l o c a t i n g personnel and f a c i l i t i e s to the money market f u n c t i o n o n l y t o the extent r e q u i r e d to handle the a n t i c i p a t e d volume of t r a n s a c t i o n s . 2. Using the most e f f i c i e n t means of matching i s s u e r s and i n v e s t o r s w h i l e r e s t r i c t i n g search and informa-t i o n g a t h e r i n g and t r a n s m i s s i o n a c t i v i t i e s to the lowest a c c e p t a b l e l e v e l s . 3. Promoting money market p a r t i c i p a t i o n by i s s u e r s and i n v e s t o r s to i n c r e a s e market a c t i v i t y by making them aware of the advantages o f such p a r t i -c i p a t i o n . While i t would seem t h a t the p r i c e o f the s e r v i c e (the commis-s i o n charges) would be v a r i e d so as to maximize p r o f i t s under a marginal r e v e n u e — m a r g i n a l c o s t approach, t h i s i s not done. Such behaviour i s not unusual given the noncompetitive nature of the schedules of fees and commission charges adhered to by members of the investment d e a l e r community. I t can be seen from the above t h a t the investment i n money market o p e r a t i o n s by a d e a l e r a c t i n g as an agent has r e l t i v e l y l i t t l e r i s k i n v o l v e d s i n c e the investment can be e a s i l y r e v e r s e d and such r i s k as does e x i s t can be minimized by i n -c r e a s i n g the accuracy of f o r e c a s t s of the f u t u r e volume of money market a c t i v i t y . When the d e a l e r a c t s as p r i n c i p a l i n a money market t r a n s a c t i o n , r a t h e r than merely a r r a n g i n g the change of owner-s h i p o f a s e c u r i t y from i s s u e r to i n v e s t o r w i t h the concurrent exchange of funds, instruments are e i t h e r b e i n g purchased by the d e a l e r f o r h i s own i n v e n t o r y or being s o l d by the d e a l e r from h i s i n v e n t o r y . The e s s e n t i a l d i f f e r e n c e between a t r a n s -a c t i o n i n which the d e a l e r i s a c t i n g as an agent and one i n which he a c t s as p r i n c i p a l i s t h a t i n the former case the dea-l e r does not at any time a c q u i r e the ownership of the s e c u r i t y i n v o l v e d w h ile i n the l a t t e r case he does. The m o t i v a t i o n f o r a purchase o f a money market i n -strument by a d e a l e r d i f f e r s from t h a t i n v o l v e d i n a s i m i l a r purchase by a money market i n v e s t o r . The i n v e s t o r regards such an instrument as an income e a r n i n g s t o r e of wealth. The d e a l e r regards such a purchase as an investment i n h i s money market o p e r a t i o n s i n the same sense as h i s a l l o c a t i o n of r e -sources to t h i s f u n c t i o n as embodied i n personnel and f a c i l i -t i e s i s an investment i n h i s money market o p e r a t i o n s . Gener-a l l y , a d e a l e r does not purchase a s e c u r i t y w i t h the i n t e n t i o n of h o l d i n g i t u n t i l i t matures and c o l l e c t i n g the i n t e r e s t and p r i n c i p a l payments. Rather, he intends to s e l l i t to an i n -v e s t o r a t a p r i c e which exceeds the purchase p r i c e by an amount which r e p r e s e n t s a r e t u r n s u f f i c i e n t to j u s t i f y h i s investment i n such o p e r a t i o n s . The e v a l u a t i o n of the p r o f i t a b i l i t y of such opera-t i o n s i n v o l v e s the same approach as t h a t used i n the case where the d e a l e r a c t s as an.agent. I f the net pr e s e n t value i s p o s i t i v e when the expected f u t u r e cash flows are disc o u n t e d by the f i r m ' s a p p r o p r i a t e l y weighted c o s t of c a p i t a l , the i n -vestment i n money market o p e r a t i o n s i n c r e a s e s the d e a l e r ' s net worth. However, u n l i k e the o p e r a t i o n s on an agency b a s i s , the c o s t of c a p i t a l i s no longer constant. Since the f i n a n c i n g o f the investment i n money market instruments i s composed of short-t e r m borrowing.in the form of c a l l loans and day-to-day loans and s i n c e t h i s i s the major p a r t of investment i n money market o p e r a t i o n s by d e a l e r s , the weighted average c o s t of c a p i t a l used as a d i s c o u n t r a t e can be approximated by the i n -t e r e s t r a t e on such loans and w i l l vary d i r e c t l y as these r a t e s v a r y . Furthermore, s i n c e the i n t e r e s t r a t e on such loans can be expected to vary i n accordance w i t h changes i n the l e v e l of i n t e r e s t r a t e s of money market instruments and s i n c e the p r i c e change of a f i n a n c i a l a s s e t i s i n v e r s e l y r e l a t e d t o a change i n the l e v e l of i n t e r e s t r a t e s , and s i n c e the r a t e s on such loans are ad j u s t e d d a i l y , a r i s e i n i n t e r e s t r a t e s r e -s u l t s i n the d e a l e r i n c u r r i n g higher c o s t s i n f i n a n c i n g an i n -vestment i n i n v e n t o r y which i s d e c l i n i n g i n market v a l u e . Con-v e r s e l y , f a l l i n g i n t e r e s t r a t e s a l l o w the d e a l e r to enjoy lower f i n a n c i n g c o s t s f o r an investment i n i n v e n t o r y with an appre-c i a t i n g market v a l u e . I t can be seen from the above t h a t g r e a t e r f i n a n c i a l r i s k i s i n v o l v e d i n the d e a l e r ' s investment i n money market o p e r a t i o n s when he ac t s as a p r i n c i p a l . In a d d i t i o n , as w e l l as having to f o r e c a s t the volume of money market a c t i v i t y , the d e a l e r must make f o r e c a s t s o f the market p r i c e s which w i l l p r e v a i l i n the f u t u r e . The d i f f i c u l t i e s encountered i n accur-a t e l y f o r e c a s t i n g changes i n i n t e r e s t r a t e s which a f f e c t both f i n a n c i n g c o s t s and s e c u r i t y p r i c e s encourages the d e a l e r to maintain low l e v e l s o f i n v e n t o r y and to minimize the l e n g t h o f time an instrument i s intended t o be h e l d i n i n v e n t o r y . The d i f f i c u l t i e s i n a c c u r a t e l y f o r e c a s t i n g i n t e r e s t r a t e changes should not dete r the d e a l e r from h o l d i n g some i n v e n t o r i e s . Even i f i t i s e q u a l l y probable t h a t i n t e r e s t r a t e s w i l l e i t h e r f a l l or r i s e , the expected value of the change i n s e c u r i t y p r i c e s i s s t i l l p o s i t i v e . T h i s downside p r o t e c t i o n r e s u l t s from the f a c t t h a t the c a p i t a l gains and c a p i t a l l o s s e s r e s u l -t i n g from equal a b s o l u t e or equal p r o p o r t i o n a t e decreases and 36 i n c r e a s e s i n y i e l d are asymmetric; t h a t i s , a decrease i n y i e l d s r a i s e s s e c u r i t y p r i c e s more than the same i n c r e a s e i n y i e l d s lowers prices."'' Since the y i e l d o f o u t s t a n d i n g money market instruments can be expected t o change as the c u r r e n t i n t e r e s t r a t e s i n the market change, the d e a l e r can expect to enjoy t h i s downside p r o t e c t i o n . M o t i v a t i o n f o r h o l d i n g h i g h l e v e l s o f i n v e n t o r y a r i s e s from the d e a l e r ' s d e s i r e to minimize p r o f i t s foregone by being unable to p r o v i d e instruments demanded by i n v e s t o r s . T h i s m o t i v a t i o n prompts the d e a l e r to promote money market p a r t i c i p a t i o n by i s s u e r s and i n v e s t o r s . When a d e a l e r i s t e m p o r a r i l y unable t o l o c a t e an i n v e s t o r w i l l i n g to purchase the instruments o f f e r e d by an i s s u e r and when an i s s u e r o f f e r s s e c u r i t i e s on a net b a s i s t o the h i g h e s t b i d d e r , the d e a l e r w i l l purchase the s e c u r i t i e s and l a t e r s e l l them to an i n v e s -t o r when demand m a t e r i a l i z e s . Such a c t i o n by the d e a l e r may r e s u l t i n lower cash r e c e i p t s to the d e a l e r i n the sh o r t run, but by f a c i l i t a t i n g the borrowing a c t i v i t i e s o f the i s s u e r , i s expected to promote f u t u r e u t i l i z a t i o n o f the money market by the i s s u e r and thus i n c r e a s e the p r o b a b i l i t y of f u t u r e cash r e -c e i p t s f o r the d e a l e r . To encourage i n v e s t o r p a r t i c i p a t i o n , the d e a l e r may purchase s e c u r i t i e s when e a r l y t e r m i n a t i o n of an investment i s sought by an i n v e s t o r and another i n v e s t o r Burton Gordon M a l k i e l , The Term S t r u c t u r e o f I n -t e r e s t Rates ( P r i n c e t o n , New J e r s e y : P r i n c e t o n U n i v e r s i t y P r e s s , 1966) , p. 55. 37 w i l l i n g t o purchase the instrument cannot be l o c a t e d . Such a c t i v i t y by the d e a l e r i n c r e a s e s the l i q u i d i t y o f money mar-ket instruments thereby r e d u c i n g the r i s k to the i n v e s t o r o f money market p a r t i c i p a t i o n and thus encourages p a r t i c i p a t i o n by the i n v e s t o r . Such p a r t i c i p a t i o n i s d e s i r e d by the d e a l e r s i n c e i t r e s u l t s i n cash i n f l o w s to him. In summary, whether the d e a l e r a c t s as an agent, as a p r i n c i p a l , or both i n h i s money market o p e r a t i o n s , the be-haviour of the d e a l e r i s assumed h e r e i n to be e x p l a i n e d by h i s attempts to maximize the net presen t value o f the expected cash flows d i s c o u n t e d by the f i r m ' s a p p r o p r i a t e l y weighted c o s t of c a p i t a l . The g r e a t e r the d e a l e r ' s investment i n money market instruments f o r h i s i n v e n t o r y , the c l o s e r the weighted average c o s t of c a p i t a l to the weighted average c o s t of day loans and c a l l loans used f o r f i n a n c i n g such investments. C o n s i s t e n t w i t h t h i s g o a l i s the p r e f e r e n c e f o r o p e r a t i o n s on an agency b a s i s w i t h the lower a s s o c i a t e d l e v e l s of r i s k . I n -volvement i n o p e r a t i o n s r e q u i r i n g i n v e n t o r i e s o f instruments r e s u l t s from the d e a l e r ' s d e s i r e to o b t a i n the cash b e n e f i t s which can be r e a l i z e d from such o p e r a t i o n s and to promote money market p a r t i c i p a t i o n by i s s u e r s and i n v e s t o r s which can be ex-pected to r e s u l t i n i n c r e a s e d f u t u r e cash i n f l o w s to the d e a l e r . 38 A F u r t h e r Aspect o f P a r t i c i p a n t i n t e r a c t i o n A phenomenon which i s c o n s i s t e n t with the behaviour-a l models o u t l i n e d above but which r e p r e s e n t s an aspect of the i n t e r a c t i o n between the p a r t i c i p a n t s i n v o l v i n g a c o n f l i c t of i n t e r e s t should be mentioned here. T r a n s a c t i o n s c o s t s are viewed by both i n v e s t o r s and borrowers as d e t r i m e n t a l t o t h e i r p r o f i t a b i l i t y o b j e c t i v e s s i n c e these c o s t s r e s p e c t i v e l y r e -duce the net presen t value of the investment and i n c r e a s e the c o s t o f short- t e r m c a p i t a l borne by these p a r t i c i p a n t s . Inas-much as t r a n s a c t i o n c o s t s accrue mainly to the investment d e a l -e r , such c o s t s as are i n c u r r e d enhance the d e a l e r ' s p r o f i t a b i l -i t y as they r e p r e s e n t cash i n f l o w s . I t may be r e c a l l e d from the example showing the c a l -c u l a t i o n of the short-term c o s t of c a p i t a l t o the money market borrower t h a t the d e a l e r ' s commission charges were the main f a c t o r i n ca u s i n g the e f f e c t i v e i n t e r e s t r a t e to be g r e a t e r than the nominal r a t e . I f no charges were l e v i e d by the d e a l e r on the i n v e s t o r , the nominal i n t e r e s t r a t e would be i d e n t i c a l to the y i e l d r e t u r n to the lender to m a t u r i t y . The g r e a t e r the d i f f e r e n c e between the e f f e c t i v e y i e l d c o s t to the i s s u e r to m a t u r i t y and the y i e l d r e t u r n to the lender to m a t u r i t y , the lower the l e v e l o f o p e r a t i o n a l e f f i c i e n c y of the money market. 1 J . Ross P e t e r s , Economics of the Canadian Corporate  Bond Market (Montreal: McGill-Queen's U n i v e r s i t y P r e s s , 1971), p. 51. T h e r e f o r e , the lower the d e a l e r ' s commission charges, the g r e a t e r the o p e r a t i o n a l e f f i c i e n c y of the money market. The m o t i v a t i o n f o r the d e a l e r t o i n c r e a s e t r a n s a c -t i o n c o s t s i s dampened by the knowledge on h i s p a r t t h a t the r e s u l t a n t lower p r o f i t a b i l i t y o f borrowers and/or i n v e s t o r s may cause them to cease to p a r t i c i p a t e i n money market opera-t i o n s . S i m i l a r l y , the m o t i v a t i o n f o r borrowers and i n v e s t o r s to t h r e a t e n withdrawal i n order to f o r c e the d e a l e r to lower t r a n s a c t i o n c o s t s i s tempered by the argument t h a t without the i n t e r m e d i a t i n g f u n c t i o n of the d e a l e r induced by p r o f i t s a r i s i n g from such t r a n s a c t i o n c o s t s , a borrower would face higher c o s t s o f short- t e r m c a p i t a l and i n v e s t o r s would have d i f f i c u l t y i n l o c a t i n g s u i t a b l e investment o p p o r t u n i t i e s . I f i s s u e r s and i n v e s t o r s f o r c e d the d e a l e r to s e t charges at a l e v e l j u s t p r o f i t a b l e enough to keep the d e a l e r from l e a v i n g the i n d u s t r y , the op t i m a l i n o p e r a t i o n a l e f f i c i e n c y i n the money market would be achieved w i t h regard to the d e a l e r commission component of t o t a l t r a n s a c t i o n s c o s t s . Thus, i t can be argued t h a t an awareness on the p a r t of the p a r t i c i p a n t s o f t h e i r i n t e r d e p e n d e n c i e s and a f a m i l i a r i t y with the b a s i c behaviour models e x p l a i n i n g p a r t i -c i p a n t behaviour are necessary to ensure the endurance of the money market. 40 I I I . THE NATURE OF THE MARKET'S STOCK-IN-TRADE Ta n g i b l e A s s e t s Versus F i n a n c i a l A s s e t s As the money market i s concerned w i t h f i n a n c i a l r a t h e r than t a n g i b l e a s s e t s , and s i n c e t h i s i m p l i e s t h a t these two types of a s s e t s d i f f e r , g r e a t e r i n s i g h t i n t o the nature of the money market may evolve from a survey o f some of the p r o p e r t i e s of t a n g i b l e and f i n a n c i a l a s s e t s . 1. T a n g i b l e a s s e t s are m a t e r i a l t h i n g s which are h i g h l y s p e c i f i c i n form and use while i n con-t r a s t f i n a n c i a l a s s e t s are predominantly gen-e r a l i z e d c l aims a g a i n s t c u r r e n t p r o d u c t i o n . 2. T a n g i b l e a s s e t s are h e l d p r i m a r i l y f o r the p h y s i c a l s e r v i c e s t h a t they y i e l d d i r e c t l y w h i le f i n a n c i a l a s s e t s are h e l d p r i m a r i l y as an a t t r a c t i v e income-earning s t o r e o f purchasing power. 3. T a n g i b l e a s s e t s are h i g h l y complementary and (except f o r consumer durables) can be made to y i e l d t h e i r s e r v i c e s i n s a l e a b l e form o n l y with the c o o p e r a t i o n o f other p r o d u c t i v e f a c t o r s . F i n a n c i a l a s s e t s are l a r g e l y supplementary, being much l e s s de-pendent on the presence of other c o o p e r a t i v e f a c t o r s . 4. T a n g i b l e a s s e t s can be i n c r e a s e d o n l y s l o w l y by net r e a l investment while f i n a n c i a l a s s e t s can be c r e a t e d or destroyed v i r t u a l l y i n s t a n -taneously by the a c t o f borrowing or repayment. 5. T a n g i b l e a s s e t s are l e s s l i q u i d than f i n a n c i a l a s s e t s , where l i q u i d i t y c h a r a c t e r i z e s the ease of c o n v e r t i n g an a s s e t i n t o money.1 These aspects o f t a n g i b l e and f i n a n c i a l a s s e t s are o u t l i n e d i n Moore, op. c i t . , pp. 11-12. 41 These a t t r i b u t e s o f t a n g i b l e and f i n a n c i a l a s s e t s i n d i c a t e t h a t each type i s sought f o r the s p e c i f i c s e r v i c e i t p r o v i d e s . F i n a n c i a l a s s e t s are sought as income-earning s t o r e s o f pu r c h a s i n g power. In a d d i t i o n to being h e l d as a form o f wealth, f i n a n c i a l r a t h e r than p h y s i c a l a s s e t s are h e l d by n o n f i n a n c i a l business f i r m s f o r t r a n s a c t i o n s and p r e c a u t i o n -ary purposes."'' While the f i n a n c i a l a s s e t s i n v o l v e d i n the c a p i t a l market are both l i q u i d and t r a d e a b l e , i t i s the money market which p r o v i d e s the g r e a t e s t l i q u i d i t y . S ince l i q u i d i t y i s an important aspect of the money market's f u n c t i o n s i t would be a p p r o p r i a t e at t h i s time to e l a b o r a t e on t h i s r a t h e r complex concept. The t h r e e motives f o r h o l d i n g cash o u t l i n e d by John Maynard Keynes, The General Theory of Employment, I n t e r e s t , and Money (New York: Harcourt, Brace & World, Inc., 1936), pp. 170-174 are the t r a n s a c t i o n s motive, the p r e c a u t i o n a r y motive, and the s p e c u l a t i v e motive. The t r a n s a c t i o n s motive i s the need f o r cash t o meet payments a r i s i n g i n the course of business such as purchases, wages, taxes, and d i v i d e n d s . The need to maintain a cushion o r b u f f e r t o meet unexpected c o n t i n g e n c i e s p r o v i d e s the p r e c a u t i o n a r y motive f o r h o l d i n g cash. The more p r e d i c t a b l e the cash flows of the b u s i n e s s , the l e s s p r e c a u t i o n a r y balances are needed. The s p e c u l a t i v e motive r e l a t e s to the h o l d i n g o f cash i n order t o take advantage of expected changes i n s e c u r i t y p r i c e s . When i n t e r e s t r a t e s are expected t o r i s e and s e c u r i -ty p r i c e s to f a l l , t h i s motive would imply t h a t the f i r m should h o l d cash u n t i l the r i s e i n i n t e r e s t r a t e s ceases to av o i d a l o s s i n s e c u r i t y v a l u e . C o n v e r s e l y , when i n t e r e s t r a t e s are expected to f a l l , cash may be i n v e s t e d i n s e c u r i -t i e s s i n c e the f i r m w i l l b e n e f i t from any subsequent f a l l i n i n t e r e s t r a t e s and r i s e i n s e c u r i t y p r i c e s . Although Keynes presented these motives as being the bases f o r h o l d i n g cash, they would be more a p p r o p r i a t e l y used as the bases f o r h o l d i n g h i g h l y l i q u i d a s s e t s i n c l u d i n g both cash and a l l near-money a s s e t s . I t would seem reasonable to 42 L i q u i d i t y In the s i m p l e s t terms l i q u i d i t y may be d e f i n e d as the a b i l i t y to r e a l i z e value i n money."'" To p o r t r a y the complex aspects of the concept of l i q u i d i t y , however, i t i s necessary 2 f i r s t to s t a t e p r e c i s e l y the f o l l o w i n g f i v e d e f i n i t i o n s . 1. The market value o f an a s s e t may be d e f i n e d as the maximum amount of money o b t a i n a b l e from the s a l e of the a s s e t , net of s e l l i n g c o s t s , a f t e r a l l u s e f u l p r i o r p r e p a r a t i o n s f o r the s a l e have been made. 2. The c a p i t a l c e r t a i n t y o f an as s e t r e f e r s to the p r e d i c t a b i l i t y w i t h which i t s expected market val u e a t f u t u r e dates i s a n t i c i p a t e d . 3. The m a r k e t a b i l i t y of an a s s e t r e f e r s to the pro-p o r t i o n o f i t s pr e s e n t market value t h a t can be r e a l i z e d i n cash a t d i f f e r e n t time i n t e r v a l s a f t e r the d e c i s i o n to s e l l . In p e r f e c t markets there are always buyers ready to purchase a s s e t s o f f e r e d a t the expect t h a t a p o r t i o n of a f i r m ' s t r a n s a c t i o n s and p r e c a u t i o n a r y balances would be h e l d i n the form o f marketable s e c u r i t i e s . For the most p a r t , n o n f i n a n c i a l b u s i n e s s f i r m s do not hold cash f o r the purpose of t a k i n g advantage of expected chan-ges i n i n t e r e s t r a t e s and t h i s r e s u l t s i n the e x c l u s i o n o f spec-u l a t i v e purposes as a reason f o r h o l d i n g f i n a n c i a l a s s e t s here. "'"This simple d e f i n i t i o n o f l i q u i d i t y i s t h a t u t i l i z e d by Van Home, op. c i t . , p. 14. 2 These d e f i n i t i o n s and the ensuing d i s c u s s i o n of the concept o f l i q u i d i t y are based on a d i s c u s s i o n on the t o p i c of l i q u i d i t y by Moore, op. c i t . , pp. 12-14. 43 present market p r i c e . In imp e r f e c t markets, how-ever, a search may have to be a f f e c t e d to l o c a t e buyers who w i l l make purchases a t presen t market p r i c e s . As the l e n g t h o f n o t i c e given f o r the s a l e i s i n c r e a s e d and the d u r a t i o n o f the search a c t i v i t y i s extended, buyers w i l l i n g t o make pur-chases a t p r i c e s approaching the pr e s e n t market va l u e w i l l be l o c a t e d . Since m a r k e t a b i l i t y i s governed by the p r i c e r e c e i v e d (net of a l l c o s t s i n c u r r e d i n e f f e c t i n g the sa l e ) r e l a t i v e to the l e n g t h of n o t i c e g i v e n , i t i s a f u n c t i o n a l r e l a t i o n as d e p i c t e d i n F i g u r e 3 below. D i f f e r e n c e s i n the d u r a t i o n of search a c t i v i t y r e q u i r e d f o r d i f f e r e n t a s s e t s r e s u l t i n d i f f e r e n c e s i n m a r k e t a b i l i t y among as s e t s which, as i n d i c a t e d i n F i g u r e 3, make im-p o s s i b l e a simple unique o r d e r i n g o f a s s e t s by mar-k e t a b i l i t y . 4. The r e a l i z a b i l i t y of an a s s e t may be d e f i n e d as the p r o p o r t i o n of i t s value t h a t can be r e a l i z e d i n cash a f t e r some sh o r t p e r i o d of time. A s s e t s can be o r -dered u n i q u e l y i n terms of t h e i r r e a l i z a b i l i t y . 5. The r e v e r s i b i l i t y o f an a s s e t may be d e f i n e d as i t s market value as a per cent o f i t s c o s t of a c q u i -s i t i o n at the same time. 44 FIGURE 3 MARKETABILITY Percentage of Pre s e n t Market Value R e a l i z e d 100 A s s e t A As s e t B 1 P e r i o d One r~ P e r i o d Two 1 P e r i o d Three Time Source: B a s i l J . Moore, An I n t r o d u c t i o n t o the Theory of  Finance, (New York -: The Free P r e s s , 1968), p.13. 45 By u s i n g these d e f i n i t i o n s i t i s p o s s i b l e to express more p r e c i s e l y what i s meant by the term l i q u i d i t y . An a s s e t which can be converted i n t o money q u i c k l y , c o n v e n i e n t l y and a t l i t t l e c o s t combines the d i s t i n c t c h a r a c t e r i s t i c s of h i g h m a r k e t a b i l i t y and h i g h c a p i t a l c e r t a i n t y . L i q u i d i t y then i n -d i c a t e s the degree to which a s s e t s combine the two p r o p e r t i e s of m a r k e t a b i l i t y and c a p i t a l c e r t a i n t y . The f i n a n c i a l a s s e t s traded i n the money market tend to be very l i q u i d i n t h a t they possess both h i g h m a r k e t a b i l i t y and h i g h c a p i t a l c e r t a i n t y . T h e i r l i q u i d i t y r e s u l t s from t h e i r h i g h q u a l i t y (they are v i r -t u a l l y d e f a u l t - f r e e ) , shortness of term to m a t u r i t y ( l i t t l e response to changes i n i n t e r e s t r a t e s ) , and the f a c t t h a t a broad market e x i s t s f o r most of the instruments i n v o l v e d . An attempt to g r a p h i c a l l y p o r t r a y the concept of l i q u i d i t y i s shown i n F i g u r e 4 below. T h i s diagram combines the concepts of m a r k e t a b i l i t y of an a s s e t as i t r e f e r s to the p r o p o r t i o n of i t s p r e s e n t market value t h a t can be r e a l i z e d i n cash over time and t h a t of c a p i t a l c e r t a i n t y as the p r o b a b i l i t y d i s t r i b u t i o n which can be assigned t o such r e a l i z a b l e propor-t i o n s of p r e s e n t market v a l u e . I t should be noted t h a t the p r o b a b i l i t y d i s t r i b u t i o n r e p r e s e n t i n g the concept of c a p i t a l c e r t a i n t y may d i v e r g e s i g n i f i c a n t l y from the symmetrical form o f a normal d i s t r i b u t i o n . In the case of a h i g h l y l i q u i d a s s e t the d i s t r i b u t i o n would be skewed toward the h i g h e r l e v e l s of p r e s e n t market v a l u e r e a l i z e a b l e . The d i s t r i b u t i o n would be skewed toward the lower l e v e l s i n the case of an i l l i q u i d a s s e t having a s u b s t a n t i a l p r o b a b i l i t y of having low l e v e l s of the present market v a l u e r e a l i z e d . 46 FIGURE 4 THE RELATIONSHIP BETWEEN MARKETABILITY AND CAPITAL CERTAINTY Percentage o f Present Market Value R e a l i z e d 100 P e r i o d One P e r i o d Two P e r i o d Three Time 47 IV. THE HISTORY OF THE MARKET AND ITS ROLE IN MONETARY POLICY C r e a t i o n of the Canadian Money Market The Canadian money market was i n f a c t d e l i b e r a t e l y c r e a t e d by the monetary a u t h o r i t i e s . Although the implemen-t a t i o n of monetary p o l i c y v i a the market r e c e i v e s c o n s i d e r a b l e a t t e n t i o n today, the market was c r e a t e d t o p r o v i d e a source of government f i n a n c i n g . An account of the development of the market by J.S.G. W i l s o n 1 i n d i c a t e s t h a t the f i r s t step to c r e a t e a market might be s a i d to have o c c u r r e d i n March 1934, when arrangements were made to s e l l Treasury B i l l s by tender. The next major development came i n January 1953, when the monetary a u t h o r i t i e s i n Canada decided to grant " l i m i t s " to c e r t a i n d e a l e r s for. the purpose of s e c u r i n g accommodation on the b a s i s of a s a l e of Treasury B i l l s under an agreement to repurchase. By t h i s means, i t was hoped to i n c r e a s e non-bank h o l d i n g of Treasury B i l l s , The next step, an important one which f a c i l i t a t e d the h o l d i n g of i n v e n t o r i e s of Treasury B i l l s by d e a l e r s , o c c u r r e d i n A p r i l 1954 when the Bank of Canada i n -v i t e d the c h a r t e r e d banks to make a v a i l a b l e to the d e a l e r s the f a c i l i t i e s f o r borrowing on a day-to-day b a s i s . In November 1955 the Bank of Canada got the c h a r t e r e d banks to agree to ma i n t a i n on a d a i l y average b a s i s a 15 per cent minimum r a t i o "''J.S.G. Wilso n , Monetary P o l i c y and the Development  of Money Markets (London: George A l l e n & Unwin L t d . , 1966), pp. 271-88. 48 of l i q u i d a s s e t s to d e p o s i t s , i n c l u d i n g the mandatory 8 per cent i n cash. T h i s had the r e s u l t o f e n s u r i n g than an app-r o p r i a t e amount o f a c t i v i t y was maintained i n the shor t - t e r m money market, by r e q u i r i n g the banks to hol d a t l e a s t a minimum t o t a l amount of Treasury B i l l s and day-to-day l o a n s . Monetary P o l i c y Subsequently the money market has become an impor-t a n t v e h i c l e f o r the implementation of monetary p o l i c i e s . V i a the market the Bank of Canada attempts to c o n t r a c t or expand the money supply by the s a l e or purchase r e s p e c t i v e l y of Treasury B i l l s and o c c a s i o n a l l y short-term Government bonds. Monetary p o l i c y has been used as an instrument to achieve the s o m e t i m e s - c o n f l i c t i n g o b j e c t i v e s o f p r i c e s t a b i l i t y , maintenance of f u l l employment, adequately r a p i d economic growth, and management of balance of payments problems. There have been suggestions t h a t the monetary p o l i c i e s o f the Bank of Canada have been f a r from s a t i s f a c t o r y and t h a t a l t e r n a t i v e g u i d i n g p r i n c i p l e s f o r the use of monetary p o l i c y should be considered."'" In any event, the market s t i l l c o n t i n u e s to play, the r o l e o f a v e h i c l e f o r monetary p o l i c y implementation. In i t s open market o p e r a t i o n s the Bank of Canada i s p r i m a r i l y attempting to a f f e c t the s i z e of the money supply. Since s h o r t - t e r m i n t e r e s t r a t e s can change without cor r e s p o n d i n g For a discussion of the objectives of Canadian mone-tary p o l i c y , see Harry G. Johnson, Essays i n Monetary Economics (London: George A l l e n & Unwin Ltd., 1967), p a r t i c u l a r l y pp. 53-54 and 196-97. changes i n the long term r a t e s i n the c a p i t a l market and s i n c e open market o p e r a t i o n s i n e v i t a b l y a f f e c t the i n t e r e s t r a t e l e v e l s o f the instruments being t r a d e d , the Bank c a r r -i e s out i t s o p e r a t i o n s i n the sh o r t end of the m a r k e t — i n the money market, t h a t i s . The p o l i c y to r e s t r i c t o p e r a t i o n s to the sho r t - t e r m money market has come to be known as the " b i l l s o n l y " p o l i c y . The primary argument f o r such a p o l i c y i s t h a t i n t e r f e r e n c e with the f i n a n c i a l market i s at a m i n i -mum when open market o p e r a t i o n s are r e s t r i c t e d t o short- t e r m i s s u e s where p r i c e f l u c t u a t i o n s are small and t r a d i n g volume i s l a r g e . 2 V. FUNCTIONS OF THE MONEY MARKET: AN EXAMPLE I t has been s a i d t h a t the money market p r o v i d e s borrowers w i t h short-term accommodation t h a t may be d i f f i c u l t 3 or more expensive to o b t a i n elsewhere. That t h i s i s p o s s i b l e may be shown by the f o l l o w i n g h y p o t h e t i c a l s i t u a t i o n . Consider an economic u n i t which wishes to e i t h e r be-come a d e f i c i t spending u n i t or to i n c r e a s e i t s d e f i c i t p o s i t i o n i f i t i s a l r e a d y a d e f i c i t u n i t . Assuming t h a t t h i s u n i t ' s s u p p l i e r s or p o t e n t i a l s u p p l i e r s r e f u s e to extend t r a d e c r e d i t to T h i s phenomenon i s d i s c u s s e d by Van Home, op. c i t . , p. 77. 2 A d i s c u s s i o n of the " b i l l s o n l y " argument i s presen-ted i n G. Walter Woodworth, The Money Market and Monetary Man-agement (New York : Harper & Row, P u b l i s h e r s , lb»bb) , pp. 2 b b - b 9 . 3Douglas H. F u l l e r t o n , The Bond Market i n Canada (Toronto: The C a r s w e l l Company L i m i t e d , LVb'l) , p. LIZ. 50 the u n i t and t h a t i t i s unable t o l o c a t e a w i l l i n g l e n d e r among the other economic u n i t s i t i s able to c o n t a c t , i t must t u r n , i n the absence of a money market, to the banking community. However, the banks may be unable t o grant a loa n to the u n i t i f the banks are i n a f u l l y loaned p o s i t i o n . Simultaneous to the d e f i c i t u n i t being denied a l o a n there un-doubtedly e x i s t s i n the banking system a d e p o s i t o r o r s u r p l u s u n i t which c o u l d be induced to exchange a l l or p a r t o f h i s savings f o r the d e f i c i t u n i t ' s promissory note o r s i m i l a r debt instrument. Access to t h i s s u r p l u s u n i t when a money market e x i s t s i s p r o v i d e d v i a an investment d e a l e r c a r r y i n g out money market o p e r a t i o n s who w i l l , f o r a f e e , l o c a t e a s u r p l u s u n i t w i l l i n g to make such an exchange. Moreover, i f the d e a l e r i s t e m p o r a r i l y unable to l o c a t e such a s u r p l u s u n i t but e i t h e r has s u f f i c i e n t a v a i l a b l e funds of h i s own or i s able t o l o c a t e a s u r p l u s u n i t w i l l i n g to le n d funds to him (assuming the d e a l e r i s unable to o b t a i n a bank l o a n ) , he may purchase the d e f i c i t u n i t ' s instrument h i m s e l f . The e x i s t e n c e of a money market f a c i l i t a t e s the f i n a n c i a l t r a n s a c t i o n sought by the d e f i c i t u n i t and a l s o prevents the d i s t u r b a n c e to the banking community from being s e r i o u s . The funds o b t a i n e d by the d e f i c i t u n i t would be exchanged f o r goods or s e r v i c e s and would e v e n t u a l l y be r e d e p o s i t e d i n the banking system by the s u p p l i e r s of these goods and s e r v i c e s . P a r t o f the d i s t u r b a n c e t h a t the banks would e x p e r i -ence, however, would be a readjustment of t o t a l r e s e r v e s caused 51 by any change of the d i s t r i b u t i o n of t o t a l d e p o s i t s between the time and demand forms. Supposedly the time d e p o s i t h o l -ders being l e s s l i q u i d i t y - o r i e n t e d and more i n t e r e s t - i n c o m e -o r i e n t e d , would respond more than demand d e p o s i t h o l d e r s to the higher r a t e s o f f e r e d by money market borrowers. I f the funds obtained by the d e f i c i t u n i t s were predominantly from time d e p o s i t h o l d e r s and r e t u r n e d to the banking community i n the predominant form of demand d e p o s i t s , the composition of t o t a l bank d e p o s i t s w i l l have changed. Since a h i g h e r l e v e l of r e s e r v e s must be maintained by banks a g a i n s t demand de-p o s i t s , the t o t a l bank r e s e r v e s would have to be i n c r e a s e d . I f the funds were not d e p o s i t e d i n the bank from which they were withdrawn by the s u r p l u s u n i t , the bank which was the o r i g i n a l d e p o s i t o r y would s u f f e r a shortage of r e s e r -ves and the new d e p o s i t o r y would have excess r e s e r v e s (assum-i n g a l l banks were o r i g i n a l l y f u l l y loaned t h a t i s , h e l d no excess r e s e r v e s ) . The money market permits the imbalance to be q u i c k l y overcome. Overcoming such an imbalance i n v o l v e s the i n t e r m e d i a t i n g or middleman p a r t i c i p a n t of the money market, the investment d e a l e r . The banks have o u t s t a n d i n g day-to-day loans which have been made to the d e a l e r . The d e a l e r u t i l i z e s such loans to purchase money market instruments f o r h i s own t r a d i n g i n v e n t o r y to ensure a ready supply of such s e c u r i t i e s to meet the demand f o r them by s u r p l u s u n i t s and a l s o to f a c i l i -t a t e the d e f i c i t u n i t 1 s borrowing a c t i v i t i e s when s u i t a b l e s u r -p l u s u n i t s cannot be immediately l o c a t e d . The bank wi t h i n -52 s u f f i c i e n t r e s e r v e s simply c a l l s s u f f i c i e n t day-to-day loans to reduce i t s loans to the l e v e l p e r m i t t e d by i t s new l e v e l of d e p o s i t s . The new d e p o s i t o r y w i t h excess r e s e r v e s i s sought out by the d e a l e r whose day-to-day lo a n has been c a l l e d , a new loan i s arranged and the t o t a l banking system remains unchanged with r e g a r d to t o t a l d e p o s i t s and loans but the d i s -t r i b u t i o n among the banks may have changed. T h i s adjustment i s shown g r a p h i c a l l y i n F i g u r e 5. Thus the money market has p r o v i d e d the d e f i c i t u n i t w i t h s h o r t - t e r m accommodation but i t must be e x p l a i n e d why the l e n -der or s u r p l u s u n i t would be encouraged to p a r t i c i p a t e . The su r p l u s u n i t can o n l y be induced to exchange h i s l o a n to the bank f o r a loan to the d e f i c i t u n i t i f the exchange leaves him b e t t e r o f f . I f the r i s k were the same and i f no l o s s o f l i -q u i d i t y were i n c u r r e d the exchange would be made i f high e r i n -t e r e s t income were expected. The g r e a t e r the r i s k and the l o s s of l i q u i d i t y , the g r e a t e r the r e q u i r e d expected i n t e r e s t income. A w e l l developed money market should keep r i s k to a minimum by a thorough s c r e e n i n g o f borrowers and minimize the l o s s o f l i q u i d i t y by f a c i l i t a t i n g broad markets f o r borrowers' l i a b i l i t i e s . The r e s u l t i s t h a t a s u r p l u s u n i t can o b t a i n higher income by i n v e s t i n g i n money market s e c u r i t i e s than by l e a v i n g h i s funds on d e p o s i t i n the bank. In many cases, the r a t e o f i n t e r e s t necessary to induce such an exchange i s below the r a t e which would be p a i d by the d e f i c i t u n i t i f the loan c o u l d be obta i n e d from the bank. In any event the r a t e would be lower than would be the case i n the absence of a money market i n 53 FIGURE 5 ADJUSTMENT OF BANK RESERVE POSITIONS THROUGH THE MONEY MARKET Bank Lo s i n g Reserves 1. S h i f t i n customers' d e p o s i t r e s u l t s i n s h i f t of Bank of Canada d e p o s i t s from f i r s t bank to second bank. Bank Ga i n i n g Reserves Investment d e a l e r uses funds from new day-to-day loan to repay day-to-day loan c a l l e d by the bank with inade-quate r e s e r v e s . Investment Dealer Investment d e a l e r o b t a i n s day-to-day loa n from bank with excess r e s e r v e s . Source: J.W. O'Brien and G. Lermer, Canadian Money and  Banking, Second E d i t i o n , (Toronto: McGraw-Hill Company of Canada L i m i t e d , 1969), p.167. which case an exchange would have to be n e g o t i a t e d between the borrower and the p o t e n t i a l l e n d e r s which c o u l d be l o -cated by the borrowers. The money market can be seen as b e n e f i t i n g the borrower i n two ways. Short-term loans are p r o v i d e d which otherwise would be d i f f i c u l t to o b t a i n and/or more expensive. By doing so the money market f a c i l i t a t e s economic a c t i v i t y and i t does so without the i n t e r f e r e n c e o f f i s c a l o r monetary a u t h o r i t i e s . The i n c r e a s e i n government d e f i c i t s o r reduc-t i o n of s u r p l u s were not necessary. The stock o f money was not a f f e c t e d but the money market has i n f a c t i n c r e a s e d the v e l o c i t y of money s i n c e g r e a t e r economic a c t i v i t y i s c a r r i e d out without an i n c r e a s e d stock of money. CHAPTER I I I CANADIAN MONEY MARKET INSTRUMENTS The money market i n Canada d e a l s i n a v a r i e t y o f i n -struments but they are a l l of a short-term nature. Although the p o i n t of d e l i n e a t i o n i s an a r b i t r a r y one, the money mar-ket , by d e f i n i t i o n , i n c l u d e s o n l y s e c u r i t i e s with l e s s than three years to m a t u r i t y . In p r a c t i c e , however, the bulk o f market a c t i v i t y occurs i n s e c u r i t i e s w i t h a term to m a t u r i t y of l e s s than one year."*" The l i s t of s e c u r i t i e s traded i n the money market i s q u i t e e x t e n s i v e and i n c l u d e s those shown i n Table I I . 2 As at December 31st, 1968, some $16 b i l l i o n i n s e c u r i -t i e s having l e s s than three years to m a t u r i t y had been i n v e s -3 t e d . There has been c o n s i d e r a b l e growth i n the market s i n c e then as evidenced by the f a c t t h a t the s e c u r i t i e s i n the mar-ket i s s u e d by the Government of Canada and the c h a r t e r e d banks (the two l a r g e s t sources of money market s e c u r i t i e s ) 4 had at October 2 8th, 1970 grown to over $15 b i l l i o n , an i n -crease of approximately 20 per cent s i n c e the end of 1968. Wood Gundy S e c u r i t i e s Limited,. The Canadian Money. Market, 1969, p. 9. 2 I b i d . , pp. 16-31. 3 I b i d . , p. 10. 4 Bank of Canada, S t a t i s t i c a l Summary (November 1970), v a r i o u s pages. 56 TABLE II INSTRUMENTS TRADED IN THE CANADIAN MONEY MARKET Government o f Canada Treasury B i l l s Short-Term Canada and Canada Guaranteed Bonds P r o v i n c i a l Treasury B i l l s or Promissory Notes P r o v i n c i a l Debentures (as the term to m a t u r i t y becomes l e s s than three years) M u n i c i p a l Promissory Notes Chartered Bank S e c u r i t i e s : Bearer Deposit Notes Deposit R e c e ipts Term Notes C e r t i f i c a t e of Deposit U.S. D o l l a r D e posits Bank Swapped Deposits E u r o d o l l a r N e g o t i a b l e C e r t i f i c a t e s o f Deposit Banker's Acceptances Day-to-Day Loans to Investment Dealers C o l l a t e r a l Loans to Investment Dealers T r u s t Company D e p o s i t s : Deposit R e c e i p t s Short Term Guaranteed T r u s t C e r t i f i c a t e s Guaranteed Investment C e r t i f i c a t e s Term C e r t i f i c a t e s Over One Year Loan and Mortgage Company S e c u r i t i e s Acceptance and Finance Company Short-Term Promissory Notes Prime Commercial Paper 57 I. THE STOCK IN TRADE OF MONEY MARKET DEALERS Some of the s e c u r i t i e s shown i n Table I I are s o l d to s h o r t - t e r m i n v e s t o r s by the i s s u e r s of the instruments, such as Term Notes which are the l i a b i l i t i e s of c h a r t e r e d banks and Guaranteed Investment C e r t i f i c a t e s which are the l i a b i l i -t i e s of t r u s t companies. While such instruments are designed to f u l f i l l the needs of r e s p e c t i v e segments of the t o t a l de-mand f o r sh o r t - t e r m investment o p p o r t u n i t i e s and f a c i l i t a t e the flow of funds between economic u n i t s , they are not the instruments of primary i n t e r e s t here. Rather, those i n s t r u -ments which make up the stock i n trade o f the money market o p e r a t i o n s o f investment d e a l e r s are to serve as the focus of t h i s chapter. These instruments are b r i e f l y d e s c r i b e d below. Government o f Canada Treasury B i l l s T reasury b i l l s are d i r e c t o b l i g a t i o n s o f the Govern-ment of Canada. They are s o l d by a u c t i o n by the Bank of Canada on b e h a l f of the M i n i s t e r of Finance every Thursday f o r d e l i v e r y F r i d a y . B i l l s are normally i s s u e d to mature i n 91 or 182 days although terms of 270 and 365 days have occa-s i o n a l l y been i s s u e d . The d e s c r i p t i o n s of these v a r i o u s instruments r e l y h e a v i l y on the p u b l i c a t i o n s of three Canadian Investment D e a l e r s ; The Canadian Short Term Money Market: Instruments  and Formulae by Burns Bros, and Denton L i m i t e d , Canada's  Short-Term Money Market by Dominion S e c u r i t i e s C o r p o r a t i o n L i m i t e d , and The Canadian Money Market by Wood Gundy S e c u r i -t i e s L i m i t e d as w e l l as from d i s c u s s i o n s with the p e r s o n n e l of v a r i o u s money market d e a l e r s and Bank of Canada o f f i c i a l s . Because t r e a s u r y b i l l s are i s s u e d weekly, depending on the p a r t i c u l a r day of purchase, they are a v a i l a b l e i n m a t u r i -t i e s of from 1 to 182 days. Only c h a r t e r e d banks and i n -vestment d e a l e r s may submit b i d s i n response to the c a l l f o r tenders a t noon each Thursday but i n v e s t o r s may pur-chase b i l l s (which are o n l y i s s u e d i n bearer form) i n denom-i n a t i o n s of $1,000, $5,000, $25,000, $100,000 and $1,000,000 from these sources. Treasury b i l l s c a r r y no coupons but are i s s u e d at a d i s c o u n t to mature at par. The increment between the pur-chase p r i c e and the s a l e p r i c e or the redemption value a t par i s f u l l y t a x a b l e as income. These instruments are t r a d i t i o n a l l y t r aded on a " y i e l d to m a t u r i t y " b a s i s r a t h e r than on a p r i c e b a s i s . The p r i c e of a t r e a s u r y b i l l can be c a l c u l a t e d u s i n g the f o l l o w i n g formula: Treasury B i l l P r i c e = 100  ioo + ( Y i e l d x Days) (365) Since the y i e l d i s t h a t d i s c o u n t r a t e which equates the pur-chase p r i c e to the net p r e s e n t value of f u t u r e cash flows a s s o c i a t e d w i t h the instrument, the y i e l d here i s i d e n t i c a l to the i n t e r n a l r a t e of r e t u r n of the investment r e p r e s e n t e d by the purchase p r i c e . The Bank of Canada uses t r e a s u r y b i l l s as a medium f o r conducting i t s open-market o p e r a t i o n s and b i l l s are an impor-t a n t p a r t of the c h a r t e r e d banks' secondary r e s e r v e s . Because 59 they are o b l i g a t i o n s of the Government and are d e f a u l t - f r e e and because a h i g h l y e l a s t i c demand e x i s t s f o r them on the p a r t o f banks and many other i n v e s t o r s , t r e a s u r y b i l l s are the most marketable o f a l l short - t e r m s e c u r i t i e s . Due to t h i s g r e a t l i q u i d i t y the e q u i v a l e n t d o l l a r spread between the b i d and asked y i e l d s i s the narrowest o f a l l money mar-ket i nstruments. Short-Term Canada and Canada Guaranteed Bonds Short-term Canada bonds are one of the most wi d e l y h e l d money market instruments, being almost as l i q u i d as t r e a s u r y b i l l s . The l i q u i d i t y of these s h o r t - t e r m f e d e r a l government o b l i g a t i o n s d e r i v e s from t h e i r b e i n g guaranteed by the government and the a c t i v e market enjoyed by the i n -struments. They are a v a i l a b l e i n bearer form with coupons at t a c h e d . "Short Canadas" are traded a t d o l l a r p r i c e s p l u s accrued i n t e r e s t . P r o v i n c i a l S e c u r i t i e s The l i q u i d i t y and y i e l d l e v e l o f p r o v i n c i a l s e c u r i t i e s depend on the c h a r a c t e r i s t i c s of the instrument and the c r e -d i t s t r e n g t h o f the i s s u i n g body. P r o v i n c i a l bonds are p r i c e d and traded i n the same manner as Government of Canada Bonds and as the term t o m a t u r i t y o f o u t s t a n d i n g debenture i s s u e s becomes l e s s than three y e a r s , they become money market instruments. 60 A p r o v i n c i a l money market instrument p o s s e s s i n g a h i g h l e v e l of l i q u i d i t y (but l e s s than t h a t possessed by f e d e r a l t r e a s u r y b i l l s and s h o r t Canadas) i s the p a r i t y -type bond i s s u e d by Crown C o r p o r a t i o n s of the P r o v i n c e o f B r i t i s h Columbia. I t i s guaranteed as to i n t e r e s t and p r i n -c i p a l by the P r o v i n c e and i s cashable a t par at any time. I t bears i n t e r e s t which i s payable q u a r t e r l y . P r o v i n c i a l t r e a s u r y b i l l s or promissory notes of many types are traded by money market d e a l e r s . Some are s o l d at par and bear a f i x e d r a t e o f i n t e r e s t or coupon while o t h e r s are s o l d a t a d i s c o u n t without a coupon and many coupon-d i s c o u n t promissory notes are i s s u e d . Notes are g e n e r a l l y i s s u e d f o r terms under one y e a r , although terms to three years are a v a i l a b l e and c e r t a i n p r o v i n c e s w i l l i s s u e notes on a "tap b a s i s " to conform e x a c t l y to the s p e c i f i c m a t u r i t y r e q u i r e d by the l e n d e r . Other p r o v i n c e s a u c t i o n t h e i r b i l l s i n a manner s i m i l a r to t h a t used to s e l l Government o f Canada t r e a s u r y b i l l s . $100,000 denominations are g e n e r a l l y a v a i l -a b l e i n e i t h e r bearer or r e g i s t e r e d form. A l l o f the p r o v i n c e s , e i t h e r d i r e c t l y or through t h e i r v a r i o u s guaranteed a u t h o r i t i e s , have used the money market f o r s h o r t - t e r m f i n a n c i n g . Repayment of p r o v i n c i a l and p r o v i n c i a l l y guaranteed borrowings r e s t s not o n l y upon the g e n e r a l c r e d i t of the i s s u i n g government, but upon i t s t a x i n g powers as w e l l . As a r e s u l t , they are second o n l y to f e d e r a l government o b l i g a t i o n s i n c r e d i t s t a n d i n g . 61 M u n i c i p a l Promissory Notes M u n i c i p a l promissory notes are i s s u e d i n the same forms as p r o v i n c i a l paper. L i q u i d i t y , however, i s more l i m i t e d . While terms vary c o n s i d e r a b l y , most are l e s s than 90 days and can o f t e n be arranged to meet the l e n d e r s ' r e -quirements. Denominations of $100,000 or more i n e i t h e r f u l l r e g i s t e r e d or bearer form can be obtained. C e r t a i n m u n i c i p a l i t i e s w i l l i s s u e t h e i r notes on a demand or c a l l b a s i s . M u n i c i p a l i t i e s tend to i s s u e notes h e a v i l y i n the wint e r months, i n a n t i c i p a t i o n o f s p r i n g or summer tax c o l l e c t i o n s . Funds may a l s o be r e q u i r e d to f i n a n c e c a p i t a l expenditures f o r which long term debt w i l l subsequently be i s s u e d . M u n i c i p a l borrowings f a l l under the s u r v e i l l a n c e of the a p p r o p r i a t e a u t h o r i t y i n each p r o v i n c e . The r e -s t r i c t i o n s as to purpose and amount vary from p r o v i n c e to p r o v i n c e . Bankers' Acceptance A Bankers' acceptance i s a n e g o t i a b l e time b i l l of exchange, or commercial d r a f t , drawn on a c h a r t e r e d bank by a borrowing company, and accepted, or guaranteed, by the bank. When the bank accepts the b i l l , i t becomes l i a b l e f o r i t s payment, so an acceptance i s , i n e f f e c t , a postdated c e r t i f i e d cheque. The c h a r t e r e d bank a c c e p t i n g the b i l l 62 charges the drawer a fee which v a r i e s with the c r e d i t of the drawing company. The drawing company then s e l l s the accep-tance to a money market d e a l e r on a d i s c o u n t b a s i s and the d e a l e r may o f f e r i t to i n v e s t o r s , borrow "day money" a g a i n s t i t , or e n t e r a purchase and repurchase agreement w i t h the Bank of Canada. Acceptances are e l i g i b l e f o r r e d i s c o u n t a t the Bank of Canada, and as s e c u r i t y f o r day-to-day loans w i t h the c h a r t e r e d banks. Under the p r o v i s i o n of the Bank of Canada A c t , a bankers 1 acceptance i s l i m i t e d to a p e r i o d hot exceeding 90 days from the date of acceptance and m a t u r i t i e s range from 30 to 90 days. An acceptance must be drawn i n connec-t i o n w i t h the p r o d u c t i o n or marketing o f goods i n order to comply w i t h p r o v i s i o n s o f the Bank of Canada A c t . I t i s not necessary, however, t h a t the acceptance be r e l a t e d to any s p e c i f i c t r a n s a c t i o n i n t r a d e . These instruments are u s e f u l to s m a l l e r n o n - f i n a n c i a l c o r p o r a t i o n s as any c o r p o r a -t i o n t h a t q u a l i f i e s under the A c t can draw them whereas o n l y the l a r g e s t c o r p o r a t i o n s can i s s u e commercial paper s u c c e s s -f u l l y . Short-term l e n d e r s have found these instruments a t t r a c t i v e as they are high e r y i e l d i n g than Government of Canada t r e a s u r y b i l l s and are guaranteed as to payment by a c h a r t e r e d bank. Acceptances are c r e a t e d by the c h a r t e r e d banks i n denominations o f $100,000 or any m u l t i p l e t h e r e o f . Bearer Deposit Term Notes Bearer d e p o s i t notes are i s s u e d by the c h a r t e r e d banks f o r terms ranging from one week to one year i n denominations i n m u l t i p l e s of $100,000. They are s o l d on a " t r e a s u r y b i l l type" d i s c o u n t b a s i s to y i e l d the i n v e s t o r the quoted r a t e and are secured by the g e n e r a l c r e d i t of the i s s u i n g bank. Money market d e a l e r s buy these notes from the c h a r t e r e d banks and r e o f f e r them on s a l e and repurchase agreements on terms from twenty-four hour demand to one year. Other Chartered Bank Short-Term Investment V e h i c l e s , T r u s t Company Deposits and Loan and Mortgage  Company S e c u r i t i e s U n l i k e bankers' acceptances and bearer d e p o s i t notes which are f r e q u e n t l y t r aded by money market d e a l e r s as p r i n -c i p a l s (that i s , from t h e i r own i n v e n t o r i e s of short-term investment v e h i c l e s ) , such c h a r t e r e d bank instruments as d e p o s i t r e c e i p t s , term notes, c e r t i f i c a t e s of d e p o s i t , U.S. d o l l a r d e p o s i t s , swapped bank d e p o s i t r e c e i p t s , and E u r o d o l l a r n e g o t i a b l e c e r t i f i c a t e s of d e p o s i t s are arranged by d e a l e r s on an agent b a s i s . T h i s l a t t e r arrangement a l s o a p p l i e s to the s h o r t - t e r m investment v e h i c l e s of t r u s t companies such as d e p o s i t r e c e i p t s , s hort-term guaranteed t r u s t c e r t i f i c a t e s , guaranteed investment c e r t i f i c a t e s , and term c e r t i f i c a t e s over one year as w e l l as to the s e c u r i t i e s of l o a n and mort-gage companies which are s i m i l a r to those of the t r u s t com-pa n i e s . These instruments (which are p l a c e d by money market d e a l e r s on an agent b a s i s ) are a c t i v e l y marketed by the r e -s p e c t i v e i s s u e r s i n c o m p e t i t i o n w i t h the money market d e a l -e r s . Such instruments vary w i d e l y i n the degree o f l i q u i d i t y they possess s i n c e many are not n e g o t i a b l e (that i s , they are n o n t r a n s f e r a b l e ) and many cannot be c a l l e d b e f o r e matur-i t y or o n l y with n e g o t i a t i o n w i t h the i s s u e r and then o f t e n w i t h p e n a l t i e s . R e a l i z i n g t h a t such instruments may, however, f i l l s p e c i f i c needs of many i n v e s t o r s , money market d e a l e r s are o b l i g e d to be i n constant touch w i t h t h i s segment of the market. Since i n t e r e s t r a t e d i f f e r e n t i a l s between n a t i o n a l money markets can r e s u l t i n f o r e i g n s e c u r i t i e s o f f e r i n g h i g h e r y i e l d s than those a v a i l a b l e i n the domestic market, d e a l e r s must keep abreast of f o r e i g n market developments and f l u c t u a t i o n s of exchange r a t e s . Acceptance and Finance Company Short-Term Promissory  Notes An a p p r e c i a b l e amount of the f i n a n c i n g needs of accep-tance and f i n a n c e companies i s r a i s e d v i a the money market. 1 T h i s short-term f i n a n c i n g i s viewed as a permanent component Canadian acceptances and f i n a n c e company short - t e r m i s s u e s are p l a c e d i n i n v e s t o r s ' hands by the investment d e a l -ers , T h i s i s i n sharp c o n t r a s t to the s i t u a t i o n i n the U n i t e d S t a t e s where some t h r e e - q u a r t e r s of the t o t a l of such paper o u t s t a n d i n g had, i n 1968, been p l a c e d d i r e c t l y w i t h i n -v e s t o r s by the i s s u e r s themselves. T h i s aspect of the U.S. market i s c i t e d i n : James C. Van Home, F i n a n c i a l Management  and P o l i c y (Englewood C l i f f s , New J e r s e y : P r e n t i c e - H a l l , Inc. 1968) , p. 413. 65 of such f i r m s ' c a p i t a l s t r u c t u r e . The proceeds of the f i n a n c e paper i s s u e d f a c i l i t a t e the' p r o v i s i o n o f i n s t a l l m e n t c r e d i t to merchandisers and to i n d i v d u a l "consumers. A wide range of consumer durable goods are f i n a n c e d by these companies a t both the wholesale and r e t a i l l e v e l s . Finance paper i s i s s u e d i n two main types, t h a t i s se-cured and unsecured. C o l l a t e r a l t r u s t notes are secured under the terms of a t r u s t indenture by the pledge and d e p o s i t of r e c e i v a b l e s with a t r u s t e e i n a d d i t i o n to the u s u a l s e c u r i t y of a f l o a t i n g charge on the a s s e t s of the company. From 112h per cent to 125 per cent of the amount of notes o u t s t a n d i n g i s the amount of r e c e i v a b l e s pledged. Unsecured f i n a n c e paper i s u s u a l l y u n c o n d i t i o n a l l y guaranteed as to p r i n c i p a l and i n t e r e s t by a parent c o r p o r a t i o n whether the s a l e s f i n a n c e company i n v o l v e d i s a s u b s i d i a r y o f e i t h e r Canadian or U.S. manufacturing or merchandising c o r p o r a t i o n s . The notes are i s s u e d without coupon i n e i t h e r r e g i s t e r e d or bearer form, normally w i t h minimum denominations of $5,0 00 and a t i s s u e are e i t h e r s o l d a t par to mature wi t h accrued i n -t e r e s t o r a t a d i s c o u n t to mature a t par. Most notes are f o r f i x e d terms of from one week to one year although terms ranging up to ten years have been arranged and some notes are repayable at the o p t i o n o f the i n v e s t o r . Although these notes are nego-t i a b l e and t r a n s f e r a b l e , they possess o n l y l i m i t e d l i q u i d i t y because they are not a l l r e a d i l y marketable and t h e r e f o r e i n -v e s t o r s are expected to h o l d them to m a t u r i t y except i n un-usu a l circumstances. Notes of the prime borrowers are g e n e r a l l y i s s u e d a t s i m i l a r r a t e s w i t h s m a l l e r f i r m s paying r a t e s up t o about 1/2 per cent h i g h e r . The notes u s u a l l y y i e l d more than t r e a s u r y b i l l s , bankers' acceptances or c h a r t e r e d bank paper. Prime Commercial Paper The unsecured promissory notes i s s u e d by some o f the l a r g e r well-known Canadian c o r p o r a t i o n s o t h e r than f i n a n c e companies are known as prime commercial paper o r c o r p o r a t e paper. T h i s instrument may be i s s u e d to supplement working c a p i t a l ; t o o f f s e t f l u c t u a t i o n s i n cash flows; to f a c i l i t a t e e xpenditures promising a r a p i d cash pay-back; or as i n t e r i m f i n a n c i n g p r i o r to an i s s u e o f s e n i o r s e c u r i t i e s . In some i n s t a n c e s much short - t e r m f i n a n c i n g may be regarded as a permanent component of a f i r m ' s c a p i t a l s t r u c t u r e . I t may serve to some degree the purpose of making the f i n a n c i a l community f a m i l i a r w i t h the s e c u r i t i e s and c r e d i t s t a n d i n g of a p a r t i c u l a r i s s u e r . Corporate paper i s backed by the g e n e r a l c r e d i t o f the i s s u e r and t h i s backing i s f r e q u e n t l y supplemented w i t h t h a t of an unused l i n e of c r e d i t w i t h the c o r p o r a t i o n ' s bank o r , when the f i r m i s a s u b s i d i a r y , the guarantee of the parent f i r m . M a t u r i t i e s range from o v e r n i g h t to one year but notes can u s u a l l y be arranged on a twenty-four hour demand b a s i s which g i v e s the le n d e r the r i g h t to demand pre-payment upon g i v i n g the i s s u e r 24 hours n o t i c e . Notes i s s u e d on a demand b a s i s u s u a l l y have the one-way c a l l by the i n v e s t o r as des-c r i b e d above but some two-way c a l l notes are arranged. Nor-mally a high e r r a t e of i n t e r e s t i s r e c e i v e d by the i n v e s t o r i f the paper runs t o m a t u r i t y than i f pre-payment i s demanded. Minimum denominations of $100,000 are i s s u e d and these notes may be r e g i s t e r e d . The notes are s o l d on an i n t e r e s t -b e a r i n g - a t - p a r b a s i s which means i n e f f e c t t h a t i n t e r e s t i s computed on the b a s i s o f r a t e s determined a t the time the investment i s made and t h a t the notes are not s o l d on a d i s -count b a s i s but at par. For the i n v e s t o r , c o r p o r a t e paper o f f e r s a r a t e of r e -t u r n higher than t h a t o f f i n a n c e company paper and a l s o po-ssesses a higher degree of l i q u i d i t y as pro v i d e d by the demand f e a t u r e . F u r t h e r to t h i s , the i n v e s t o r can s e l e c t both the i s s u i n g date and the m a t u r i t y t o c o i n c i d e w i t h h i s a n t i c i p a t e d needs. For the i s s u e r , c o r p o r a t e paper p r o v i d e s the means of tappi n g the short-term money market f o r funds f o r the above 68 mentioned purposes at a lower c o s t than borrowing from char-t e r e d banks. The borrower, however, i s expected by i n v e s t o r s to have bank l i n e s of c r e d i t a v a i l a b l e to cover a l l paper out-standing.''" I n v e s t o r s i n c o r p o r a t e paper a l s o r e q u i r e t h a t i s s u i n g companies p r o v i d e documentation i n support of t h e i r investment. Such documentation i s normally presented i n a 2 brochure and normally i n c l u d e s the f o l l o w i n g : 1. The l a t e s t annual r e p o r t , p r e f e r a b l y i n c l u d i n g a f i v e year comparative f i n a n c i a l summary, 2. a resume of the nature of the company and i t s o p e r a t i o n s , 3. a copy of the borrowing by-law, 4. a r e s o l u t i o n of the company concerning borrowing of s h o r t - t e r m money, 5. a l e g a l o p i n i o n by the company's counsel concerning the i s s u e of notes, 6. i f a v a i l a b l e , a l e g a l o p i n i o n by the company's counsel c oncerning the l e g a l i t y o f the notes f o r T h i s aspect of borrowing v i a the issuance of c o r p o r a t e paper i s e x p l i c i t l y mentioned i n the b o o k l e t p u b l i s h e d by Burns Bros, and Denton L i m i t e d , The Canadian Short-Term Money Market: Instruments and Formulae, Toronto, 1965, p. 18. Borrowers would be expected to have such l i n e s of c r e d i t a v a i l a b l e t o p r o v i d e i n v e s t o r s w i t h c o n f i d e n c e t h a t , a t m a t u r i t y or i n the event of a two-way c a l l being e x e r c i s e d by the i n v e s t o r , funds w i l l be a v a i l a b l e to meet repayment requirements. I f the borrower encountered f i n a n c i a l d i f f i c u l t i e s and repayment of notes c o u l d not be generated from o p e r a t i o n s , u n l e s s the bank l i n e s of c r e d i t were being p a i d f o r , the c o r p o r a t i o n would be hard-pressed to convince i t s bank t o allow the f u l l use of such l i n e s of c r e d i t . 2An example of such a brochure (excluding the annual r e -port) i s shown i n Appendix A where a copy of the c u r r e n t o f f e r -i n g memorandum o f B.C. Telephone i s shown. investment by l i f e i n s urance companies, as w e l l as t r u s t companies, whether f e d e r a l l y or p r o v i n c i a l l y i n c o r p o r a t e d , 7. specimen s i g n a t u r e s of c o r p o r a t e s i g n i n g o f f i c e r s and a company c e r t i f i c a t e a t t e s t i n g to t h e i r v a l i -d i t y , 8. specimen short-term notes, 9. the name of the company"'s banker and l i n e of c r e d i t , and 10. i n the event of a p a r e n t a l guarantee, a d d i t i o n a l documentation p e r t a i n i n g to the parent i s r e q u i r e d . A d i s t i n c t segment of commercial paper i s the promissory notes i s s u e d by g r a i n companies to f i n a n c e the purchase, s t o r -age and t r a n s p o r t a t i o n of g r a i n . G r a i n paper i s i s s u e d at par and bears i n t e r e s t a t a s t a t e d r a t e . Most notes are on a de-mand b a s i s w i t h a two-way c a l l , but f i x e d terms can be n e g o t i a -ted up to 90 days. They can be c a l l e d f o r same day payment i f adequate n o t i c e i s g i v e n ( p r i o r to noon E a s t e r n time).''" Most of the g r a i n handled by the g r a i n companies i s e n t i r e l y f o r the account of the Canadian Wheat Board which pays the g r a i n company f o r a l l i t s c o s t s p l u s a h a n d l i n g margin upon d e l i v e r y o f a t e r m i n a l warehouse r e c e i p t . As w e l l as a •'•This d e s c r i p t i o n of " g r a i n paper" l i q u i d i t y i s out-l i n e d i n the money market b o o k l e t of Burns Bros, and Denton L i m i t e d , op. c i t . , p. 17. 70 h i g h degree of l i q u i d i t y , g r a i n paper has a h i g h degree of s a f e t y s i n c e any l o s s e s i n c u r r e d from the f i n a l s a l e of the g r a i n are borne by the Canadian Wheat Board. Day-To-Day Loans to Investment Dealers Day-to-day loans are one of the three p r i n c i p a l t e c h -niques u t i l i z e d by investment d e a l e r s to f i n a n c e i n v e n t o r i e s of s e c u r i t i e s . These i n v e n t o r i e s a r i s e from the d e a l e r s ' f u n c t i o n of m a i n t a i n i n g t r a d i n g markets i n s e c u r i t i e s and a l s o as a r e s u l t of c a r r y i n g a p o s i t i o n i n a new i s s u e b e f o r e i t has been completely p l a c e d w i t h i n v e s t o r s . The other main methods of f i n a n c i n g such i n v e n t o r i e s are c a l l loans or co-l l a t e r a l loans and repurchase agreements or buy-backs. These are o u t l i n e d below. Day-to-day loans are used as an investment p r i m a r i l y by c h a r t e r e d banks but a l s o may be u t i l i z e d by o t h e r i n s t i t u -t i o n a l i n v e s t o r s . As s e c u r i t y f o r such loans the investment d e a l e r lodges Government of Canada t r e a s u r y b i l l s , Government of Canada bonds maturing w i t h i n three y e a r s , or bankers' acceptances e i t h e r w i t h the lender or h i s d e s i g n a t e d d e p o s i t o r y . Such loans are always s u b j e c t to a two-way c a l l so t h a t e i t h e r p a r t y may c a l l them at any time up to noon f o r same day s e t t l e -ment . Day-to-day loans were inaugurated i n 1954 when they were d e s i g n a t e d by the Bank of Canada as a c c e p t a b l e instruments f o r the secondary r e s e r v e requirements of the c h a r t e r e d banks. As a r e s u l t o f the h i g h degree of l i q u i d i t y of such l o a n s , be-i n g r e a d i l y c a l l a b l e and secured by h i g h - q u a l i t y , r e a d i l y marketable s e c u r i t i e s , day-to-day loans normally bear the low-e s t r a t e of r e t u r n of a l l money market instruments. The r a t e of i n t e r e s t p a i d on these loans i s known as the day r a t e (the r a t e at which a u t h o r i z e d d e a l e r s can borrow from the c h a r t e r e d banks u s i n g the above mentioned s e c u r i t i e s as c o l l a t e r a l ) s u b j e c t to d a i l y r e v i s i o n and while a d e a l e r can f i x the r a t e a t which a loan w i l l be made f o r c e r t a i n p e r i o d s , the l o a n r a t e normally f l u c t u a t e s along w i t h the day r a t e . Funds can n e a r l y always be accepted i n m u l t i p l e s of $100,000. C o l l a t e r a l Loans or C a l l Loans While t h i s type of l o a n to investment d e a l e r s i s s i m i l a r to the day-to-day lo a n o u t l i n e d above, a higher r a t e of r e -t u r n i s o f f e r e d s i n c e d i f f e r e n t s e c u r i t i e s are used as c o l l a t -e r a l . A l s o , these loans can a f f o r d g r e a t e r f l e x i b i l i t y as to term and r a t e . S e c u r i t i e s other than those used as c o l l a t e r a l f o r day-to-day loans can be pledged (those a c t u a l l y used are n e g o t i a t e d by the p a r t i e s involved) w i t h the g r e a t m a j o r i t y being arranged u s i n g as c o l l a t e r a l Government of Canada medium and long term bonds, p r o v i n c i a l t r e a s u r y b i l l s and debentures, Canadian c h a r t e r e d bank bearer d e p o s i t notes,and top grade s h o r t term f i n a n c e and commercial paper. As w e l l as the s e c u r i t i e s i n -v o l v e d , the amount of the loan,.the r a t e and the terms are a l s o s u b j e c t to n e g o t i a t i o n . The s e c u r i t i e s are o f t e n h e l d by a bank or by the d e a l e r i n safekeeping f o r the account of the l e n d e r and the d e a l e r u s u a l l y has the r i g h t of s u b s t i t u t i o n of a c c e p t a b l e s e c u r i t i e s f o r those he may need f o r d e l i v e r i e s . The term o f the l o a n i s u s u a l l y on a two-way c a l l b a s i s e i t h e r f o r same or one-^day se t t l e m e n t , depending on the agreement but many loans are n e g o t i a t e d f o r a f i x e d number of days. Repurchase Agreement or Buy-Backs I t i s an arrangement of t h i s type which p r o v i d e s money market d e a l e r s w i t h access to a source of i n v e n t o r y f i n a n c i n g which i s a v a i l a b l e when other sources are not a v a i l a b l e . The purchase and r e s a l e agreements made by the Bank of Canada r e s u l t i n i t s p o s i t i o n as a l e n d e r of l a s t re s o r t to money market d e a l e r s . In an attempt to broaden the money market the Bank of Canada began e n t e r i n g i n t o purchase and r e s a l e agreements with a number o f investment d e a l e r s so t h a t these d e a l e r s c o u l d s e l l t r e a s u r y b i l l s and short-term Government of Canada bonds to the Bank wit h an undertaking to repurchase them w i t h i n a r e l a t i v e l y s h o r t p e r i o d of time at a p r i c e to net the Bank a predetermined r a t e of i n t e r e s t . 73 In 1954 t h i r t e e n investment d e a l e r s were gi v e n l i n e s of c r e d i t by the Bank c o v e r i n g the repurchase agreements. Bankers' acceptances become e l i g i b l e f o r such agreements i n 1962. The term of such agreements w i t h the Bank i s l i m i t e d to two days and the r a t e which has always been regarded as a p e n a l t y r a t e or one t h a t would discourage unwarranted use o f the f a c i l i -t i e s i s c u r r e n t l y s e t a t one q u a r t e r of one per cent above the average r a t e on t r e a s u r y b i l l s o r t h r e e q u a r t e r s of one per cent below the Bank Rate, whichever i s h i g h e r . Other l e n d e r s can enter s i m i l a r agreements w i t h a d e a l e r u s i n g the s e c u r i t i e s noted above or any other s a t i s -f a c t o r y s e c u r i t i e s t h a t would be used f o r c a l l loan purposes. Such agreements are a p p r o p r i a t e where l i q u i d i t y i s not neces-sary and when an i n v e s t o r wishes to i n v e s t h i s funds f o r a p a r t i c u l a r p e r i o d f o r which no adequate s h o r t - t e r m s e c u r i t i e s w ith the r e q u i r e d m a t u r i t y e x i s t s . E s s e n t i a l l y , a buy-back or repurchase agreement i s simply the s a l e of s p e c i f i e d s e c u r i t i e s a t a f i x e d p r i c e and the simultaneous undertaking by the d e a l e r to repurchase the s e c u r i t i e s a t a h i g h e r p r i c e a t a f u t u r e date to g i v e the lender an agreed r a t e of r e t u r n . The d i f f e r e n c e i n p r i c e s i s t r e a t e d as i n t e r e s t income and i s f u l l y t a x a b l e . Summary An examination of the money market instruments des-c r i b e d above i n d i c a t e s t h a t a unique r a n k i n g of these i n s t r u -74 ments a c c o r d i n g to t h e i r t hree main c h a r a c t e r i s t i c s of r i s k , l i q u i d i t y , and y i e l d to m a t u r i t y i s i m p o s s i b l e . They can be ranked a c c o r d i n g to the c r e d i t worthiness o f the i s s u e r i n ascending o r d e r as f o l l o w s : 1. Government of Canada Treasury B i l l s and Short Canadas, 2. P r o v i n c i a l I s s u e s, 3. M u n i c i p a l Issues, 4 . Bankers' Acceptances, Bearer Deposit Term Notes, .Trust Company D e p o s i t s , Loan and Mortgage Company S e c u r i t i e s , and Other C h a r t e r e d Bank Investment V e h i c l e s , 5. Acceptance and Finance Company Notes, and 6. Prime Commercial Paper, Day Loans and C a l l Loans to Investment D e a l e r s , and Buy-Backs. A c c o r d i n g to the l e v e l o f l i q u i d i t y possessed, the r a n k i n g o f these instruments i n d e c l i n i n g order i s as f o l l o w s : 1. Government o f Canada Treasury B i l l s , 2. Short Canadas, 3. P r o v i n c i a l I s s u e s , 4 . M u n i c i p a l I s s u e s , 5. Bankers' Acceptances and Bearer Deposit Term Notes, 6. Other C h a r t e r e d Bank Investment V e h i c l e s , T r u s t Company D e p o s i t s , and Loan and Mortgage Company S e c u r i t i e s , 75 7. Day Loans and C a l l Loans to Investment D e a l e r s , 8. Prime Commercial Paper and Acceptance and F i -nance Company Notes, and 9 . Buy-Backs. F i n a l l y , the instruments are ranked below i n ascending order a c c o r d i n g to y i e l d to m a t u r i t y . The r a t e s shown are those which p r e v a i l e d at March 4 , 1 9 7 1 and are f o r the m a t u r i t i e s i n d i c a t e d . 1 Due to the range of r a t e s p r e v a i l i n g w i t h i n some c a t e g o r i e s , there i s a c o n s i d e r a b l e amount of o v e r l a p p i n g of c a t e g o r i e s . Instrument 1 . Canada Treasury B i l l s 2 . Day-to-Day Loans 3 . Bank of Canada Buy-Backs 4. P r o v i n c i a l and M u n i c i p a l Issues 5. Short Canadas 5. Bankers' Acceptances 7. C h a r t e r e d Bank Deposits 8. T r u s t Company Deposits 9 . Prime Commercial Paper 1 0 . Accept.and Finance Paper 1 1 . C a l l Loans to Investment Dealers Y i e l d to M a t u r i t y (%) 3 . 8 0 - 3 . 9 8 4 . 5 0 4 . 5 0 4 . 7 5 - 5 . 0 0 4 . 8 1 - 5 . U 4 4 . 8 5 4 . 90 5 . 00 4 . 7 5 - 5 . 5 0 5 . 0 0 - 5 . 6 3 5 . 5 0 - 6 . 0 0 M a t u r i t y 1 week to 2 6 weeks demand 1 or 2 days 30 to 5 9 days up to 3 years 30 days 3 0 days 3 0 days demand to 2 9 days 1 to 2 9 days demand These r a t e s were o b t a i n e d from Bank of Canada, S t a t i s -t i c a l Summary ( A p r i l , 1 9 7 1 ) , p. 2 5 5 , Wood Gundy S e c u r i t i e s L i m i t e d , "The Money Market", March 4 , 1 9 7 1 (weekly), and Mr. George Mainwaring, Manager of Investments,Bank of Nova S c o t i a . 76 The instruments d e s c r i b e d above r e p r e s e n t the stock i n trade of investment d e a l e r s p a r t i c i p a t i n g i n money market op-e r a t i o n s , By means of these v a r i o u s instruments, borrowers are able t o tap the pools o f c a p i t a l f o r t h e i r s h o r t - t e r m f i -nancing needs. For i n v e s t o r s , these instruments o f f e r v a r i o u s degrees of r i s k and l i q u i d i t y w i t h a s u f f i c i e n t range of ma-t u r i t i e s and r e t u r n s to p r o v i d e a c c e p t a b l e o p p o r t u n i t i e s to meet t h e i r s hort-term investment needs. The purpose of t h i s chapter has been to e x p l i c i t l y de-s c r i b e the instruments i n v o l v e d i n the Canadian money market which were d i s c u s s e d i n a g e n e r a l and more a b s t r a c t manner i n Chapter I I . These are the instruments which are a c t u a l l y i n -v o l v e d i n the equating o f the supply and demand o f short- t e r m c a p i t a l and which are i n v o l v e d i n the processes d e s c r i b e d p r e -v i o u s l y i n the p a r t i c i p a n t behaviour models. In the course of the f o l l o w i n g p a r t s of t h i s study, r e f e r e n c e w i l l be made to v a r i o u s aspects o f these instruments. The above d e s c r i p t i o n s , t o gether w i t h the concepts o u t l i n e d i n the p r e v i o u s chapter, comprise the b a s i c aspects of money market a c t i v i t i e s which r e q u i r e understanding i n order to proceed w i t h a c r i t i c a l ex-amination of the Vancouver money market. 77 CHAPTER IV THE RECENTLY EVOLVED VANCOUVER MONEY MARKET AND ITS LOW LEVEL OF DEALER INVENTORIES Chapters I I and I I I have examined the o v e r a l l s e t t i n g i n which the Vancouver money market e x i s t s . Since most of the aspects of the Canadian money market as o u t l i n e d t h e r e i n apply e q u a l l y to the Vancouver and the Toronto-Montreal mar-k e t s , the d e s c r i p t i o n o f the Vancouver money market, which i s a s t a t e d o b j e c t i v e of t h i s study, has a l r e a d y begun. Chapters IV and V w i l l complete the d e s c r i p t i o n as w e l l as o u t l i n i n g and, where p o s s i b l e , e x p l a i n i n g the major i m p e r f e c t i o n s and p e c u l i a r i t i e s o f the Vancouver money market. These two chap-t e r s r e l y h e a v i l y on the i n f o r m a t i o n gathered from the s e r i e s of i n t e r v i e w s conducted w i t h the f i f t e e n Vancouver money mar-ket p a r t i c i p a n t s i d e n t i f i e d i n Table I. Chapter IV looks f i r s t a t the r e c e n t growth of the Vancouver money market. I t i n d i c a t e s the degree of i n v o l v e -ment by the investment d e a l e r community, notes the i n c r e a s e d p a r t i c i p a t i o n by l o c a l borrowers, and compares the volume of l o c a l - money market investment to t h a t of Eastern-based i n -v e s t o r s . The second p a r t of the chapter d i s c u s s e s the major p e c u l i a r i t y or i m p e r f e c t i o n o f the Vancouver money market; t h a t ' i s , the low l e v e l s of i n v e n t o r i e s o f money market i n s t r u -ments maintained by investment d e a l e r s i n Vancouver. The fou r f a c t o r s c o n t r i b u t i n g to the maintenance of such l e v e l s o f i n -v e n t o r i e s are d i s c u s s e d and the chapter concludes w i t h d i s -c u s s i o n s o f the i m p l i c a t i o n s o f the i n v e n t o r y aspect o f l o c a l money market c o n d i t i o n s f o r both i n v e s t o r s and borrowers. I. THE RECENT GROWTH OF THE VANCOUVER MONEY MARKET The Vancouver money market as i t c e n t e r s around the investment d e a l e r can be d e s c r i b e d as a small but growing mar-ke t . L o c a l money market p a r t i c i p a n t s are i n g e n e r a l agree-ment t h a t the year 1966 marked the beginning o f the presen t p e r i o d of i n c r e a s i n g a c t i v i t y by investment d e a l e r s i n Van-couver. Since then d e a l e r s have expanded t h e i r l o c a l s t a f f and broadened the range o f s e r v i c e s o f f e r e d to l o c a l p a r t i c i -pants o f f i n a n c i a l markets. I n c r e a s i n g l y the money market jobbers have sought access to t h i s r e g i o n by opening branch o f f i c e s i n Vancouver. Table I I I l i s t s the investment d e a l e r s who q u a l i f y as money market "jobbers" and thus occupy a c e n t r a l p o s i t i o n i n the Canadian money market. A "jobber" i s d e f i n e d as an i n -vestment d e a l e r who has access to the "lender of l a s t r e s o r t " f a c i l i t i e s of the Bank of Canada v i a the Bank's purchase and 79 TABLE I I I MONEY MARKET JOBBERS 1 Ames, A.E., & Co. L i m i t e d Burns Bros. & Denton L i m i t e d Dominion S e c u r i t i e s Corp. L i m i t e d E q u i t a b l e S e c u r i t i e s Canada L i m i t e d F r y & Company L i m i t e d Gairdner & Company L i m i t e d G r e e n s h i e l d s and Company Inc., H a r r i s & P a r t n e r s L i m i t e d McLeod, Young, Weir & Co. L i m i t e d Midland-Osier S e c u r i t i e s L i m i t e d M i l l s , Spence & Company L i m i t e d N e s b i t t , Thomson & Company L i m i t e d Richardson S e c u r i t i e s o f Canada Royal S e c u r i t i e s Corp.. L i m i t e d Wood Gundy S e c u r i t i e s L i m i t e d With the e x c e p t i o n of F r y & Company L i m i t e d who became money market jobbers i n 1965, the l i s t i s the same as t h a t pub-l i s h e d i n the Investment D e a l e r s 1 A s s o c i a t i o n B r i e f to The Royal Commission on Banking and Finance i n June of 1962. r e s a l e agreements. Of the f i f t e e n money market jobbers l i s t e d i n Table I I I , o n l y three do not have o f f i c e s l o c a t e d i n Van-couver. These three a r e : E q u i t a b l e S e c u r i t i e s Canada L i m i t e d , H a r r i s & P a r t n e r s L i m i t e d , and M i l l s , Spence & Company L i m i t e d . The most r e c e n t a r r i v a l on the Vancouver scene i s Fry & Com-pany who opened an o f f i c e here i n March, 1971. The f a c t t h a t twelve of the f i f t e e n money market jobbers have o f f i c e s i n Vancouver does not, however, mean t h a t a l l twelve of them are a c t i v e l y i n v o l v e d i n money market op-e r a t i o n s i n a manner (not to mention s c a l e ) s i m i l a r to t h e i r E a s t e r n o p e r a t i o n s . In f a c t , o n l y f i v e o f these twelve d e a l -e r s can be s a i d to have money market desks. That i s , on l y f i v e of these d e a l e r s c a r r y s i g n i f i c a n t i n v e n t o r i e s o f money market instruments l o c a l l y and have at l e a s t one person i n the l o c a l o f f i c e whose s o l e concern i s the money market o p e r a t i o n s . In most of the ot h e r s the money market i s handled by a bond t r a d e r . Inasmuch as s i g n i f i c a n t i n v e n t o r i e s are c a r r i e d and a f u l l time money market s t a f f i s maintained, the f i v e i n v e s t -ment d e a l e r s w i t h the most complete l o c a l money market opera-t i o n s a r e : A.E. Ames & Co. L i m i t e d , Dominion S e c u r i t i e s Corp. L i m i t e d , McLeod, Young, Weir & Co. L i m i t e d , 81 N e s b i t t , Thomson & Company L i m i t e d , and Wood Gundy S e c u r i t i e s L i m i t e d . N e v e r t h e l e s s , s i n c e 1966 one of the s e r v i c e s made more widely a v a i l a b l e i n Vancouver has been the d e a l e r s ' money mar-ket o p e r a t i o n s . But u n l i k e the Toronto-Montreal market where many borrowers and l e n d e r s had been aware of the b e n e f i t s to be d e r i v e d from p a r t i c i p a t i o n i n such a market, the f i n a n c i a l community of Vancouver had had l i t t l e o p p o r t u n i t y to p e r c e i v e the need f o r such s e r v i c e s . In f a c t , before 1968 o n l y two or three borrowers of s h o r t - t e r m funds even e x i s t e d i n Vancouver. 1 At p r e s e n t , however, the money market i s u t i l i z e d as a source of s h o r t - t e r m f i n a n c i n g by a c o n s i d e r a b l e number of o r g a n i z a -t i o n s l o c a t e d i n the Vancouver a r e a . Short-term debt i n s t r u -ments are of course i s s u e d by the r e s i d e n t branches of the c h a r t e r e d banks and t r u s t companies as w e l l as t h e i r Vancouver-based c o m p e t i t o r s , the Bank of B r i t i s h Columbia and Y o r k s h i r e T r u s t Company. The l a t t e r f i r m s are r e l a t i v e newcomers to the money market; the f i r m s themselves have been i n e x i s t e n c e f o r 2 r e l a t i v e l y s h o r t p e r i o d s . Other l o c a l l y - b a s e d i s s u e r s of debt G.H. Eaton and D.E. Bond, "Canada's Newest Money Market: Vancouver," The Canadian Banker (November-December, 1970), p.15. 2 The Bank of B r i t i s h Columbia i n f a c t r e c e i v e d i t s char-t e r i n December of 1966 but a c t u a l o p e r a t i o n s commenced wit h the opening of i t s f i r s t branch i n J u l y of 1968. Y o r k s h i r e T r u s t Company, although i t evolved from an o r g a n i z a t i o n p r o v i -d i n g v a r i o u s f i n a n c i a l s e r v i c e s i n B r i t i s h Columbia d a t i n g back to 1888, was e s t a b l i s h e d i n 1965 and commenced o p e r a t i o n s i n 1966. instruments which q u a l i f y as money market instruments i n c l u d e merchandisers, f i n a n c i a l i n s t i t u t i o n s , manufacturers, p r o c e s s -o r s , u t i l i t i e s , and d i s t r i b u t o r s as w e l l as p r o v i n c i a l and m u n i c i p a l government bodies and t h e i r a g e n c i e s . E x c l u d i n g the Bank o f B r i t i s h Columbia, Y o r k s h i r e T r u s t Company and the l o c a l governments and t h e i r a g e n c i e s , the l o c a l i s s u e r s of money market instruments are those ten o r g a n i z a t i o n s shown i n Table IV. Based on the l i m i t a t i o n s of borrowing by means of the issuance of short-term promissory notes as s e t down i n the borrowing bylaws of the companies, and shown i n Table IV, the p o t e n t i a l volume of such s h o r t - t e r m notes which could be i s s u e d i n t o t a l by the aforementioned ten o r g a n i z a t i o n s i s estimated to be of the magnitude of about $172 m i l l i o n s . However, i t i s u n l i k e l y t h a t t h i s p o t e n t i a l volume o f sh o r t - t e r m notes would be reached a t any p a r t i c u l a r p o i n t i n time due to the f a c t t h a t the c y c l i c a l needs f o r s h o r t - t e r m funds by these f i r m s do not c o i n c i d e . In f a c t at t h i s p o i n t some o f the f i r m s l i s t e d above have s h o r t - t e r m notes o u t s t a n d i n g to the e x t e n t t h a t such b o r r -owing i s a t or near t h e i r l i m i t s w h i le o t h e r s are f a r below t h e i r l i m i t s and some have e i t h e r none or very l i t t l e o f such l i a b i l i t i e s o u t s t a n d i n g . Of the estimated $172 m i l l i o n which c o u l d p o s s i b l y be o u t s t a n d i n g i f a l l of these borrowers were to be borrowing a t t h e i r l i m i t s - a t the same time, i t i s e s t i -mated t h a t t h e r e i s c u r r e n t l y o u t s t a n d i n g between $75 m i l l i o n s and :.$_80 m i l l i o n s i n s h o r t - t e r m promissory notes. 83 TABLE IV SOME LOCAL ISSUERS AND THEIR BORROWING LIMITS ON SHORT-TERM PROMISSORY NOTES O r g a n i z a t i o n L i m i t ( i n m i l l i o n s ) B r i t i s h Columbia C e n t r a l C r e d i t Union $ 10 B r i t i s h Columbia Packers L i m i t e d 15 B r i t i s h Columbia Telephone Company 55 Cunningham Drug Stores L i m i t e d 5 Inl a n d N a t u r a l Gas Co. L t d . 5 K e l l y Douglas and Company L i m i t e d 2 L a u r e n t i d e F i n a n c i a l C o r p o r a t i o n L t d . 25 MacMillan B l o e d e l L i m i t e d 40 Weldwood o f Canada L i m i t e d 5 Woodward Stores L i m i t e d 10 The money market borrowing l i m i t s ^ of these o r g a n i z a t i o n s were ob t a i n e d from Mr. Robert Levers o f McLeod, Young, Weir & Co., L i m i t e d . The estimates of both p o t e n t i a l and c u r r e n t l y out-s t a n d i n g s h o r t - t e r m l i a b i l i t i e s of the ten f i r m s c i t e d a-bove are estimates o n l y of the s h o r t - t e r m l i a b i l i t i e s t h a t are i n the form of s h o r t - t e r m promissory notes and do not i n c l u d e s h o r t - t e r m l i a b i l i t i e s t h a t are i n the form of bankers' acceptances. While most of the companies mentioned above use bankers' acceptances as a means of o b t a i n i n g s h o r t -term f i n a n c i n g , i t has not been p o s s i b l e to formulate an es-timate of what the p o t e n t i a l volume of such borrowings might be. The c u r r e n t l e v e l of the bankers' a c c e p t a n c e s o u t s t a n d i n g f o r these f i r m s i s estimated to be approximately $35 millions.''" Although the p a r t i c i p a n t s which were i n t e r v i e w e d gen-e r a l l y agree t h a t the demand f o r money market instruments on the p a r t of l o c a l i n v e s t o r s has grown at a r a t e s i m i l a r t o the r e c e n t growth o f money market a c t i v i t y by l o c a l i s s u e r s , t a n g i b l e evidence to support t h i s view c o u l d not be o b t a i n e d . The t o t a l l o c a l investment i n money market instruments i s not l a r g e , however. I t i s c u r r e n t l y estimated t h a t such investment by Vancouver i n v e s t o r s a t any p a r t i c u l a r time would range be-tween $300 m i l l i o n and $400 m i l l i o n which i s judged to be at most 10 per cent o f such investment by Toronto-and M o n t r e a l -"*"This i s the amount of such instruments o u t s t a n d i n g as estimated by Mr. Robert Levers of McLeod, Young, Weir & Co. L i m i t e d . 85 based i n v e s t o r s . While i t i s not p o s s i b l e to prese n t a d e t a i l e d des-c r i p t i o n o f the l o c a l demand.for money market s e c u r i t i e s , two aspects of t h a t demand can be mentioned. F i r s t , the es-timates by the v a r i o u s d e a l e r s i n t e r v i e w e d i n d i c a t e t h a t up-wards of t h i r t y per c e n t . o f the t o t a l l o c a l investment i n money market s e c u r i t i e s c o n s i s t s o f l o c a l l y - i s s u e d i nstruments. Second, o n l y a smal l p o r t i o n of t o t a l money market investment i n v o l v e s s h o r t - t e r m Canada bonds or f e d e r a l t r e a s u r y b i l l s . Other than those purchased by the Bank o f B r i t i s h Columbia there e x i s t s no s i g n i f i c a n t demand f o r these s e c u r i t i e s i n the Vancouver a r e a . These instruments together account f o r about $5.5 m i l l i o n of the Bank o f B r i t i s h Columbia's p o r t f o l i o r e q u i r e d f o r secondary r e s e r v e s w i t h t r e a s u r y b i l l s c omprising the l a r g e r p o r t i o n . I t i s estimated by Bank of B r i t i s h Colum-b i a o f f i c i a l s t h a t the t o t a l o f a l l other l o c a l demand f o r t r e a s u r y b i l l s and short - t e r m Canada bonds would not a t any time exceed $1 m i l l i o n . In summary, the expansion of the Vancouver money market i s r e f l e c t e d i n the r e c e n t i n f l o w o f money market personnel to investment d e a l e r s ' o f f i c e s l o c a t e d i n Vancouver, the growing number of f i r m s which have found the market a l u c r a t i v e source These estimates are d e r i v e d from the guesstimates o f the money market personnel of the l o c a l d e a l e r s i n t e r v i e w e d i n the course of t h i s study. of s h o r t - t e r m investment v e h i c l e s , and the s w e l l i n g ranks o f the Vancouver-based es t a b l i s h m e n t s which f r e q u e n t l y and/or c o n t i n u o u s l y c a p i t a l i z e on the o p p o r t u n i t y to tap t h i s grow-i n g source of funds. Understandably, l o c a l money market par t i c i p a n t s express c o n s i d e r a b l e s a t i s f a c t i o n and p r i d e about the r e c e n t growth i n the market. To them t h i s growth r e p r e -sents the f i n a n c i a l coming of age of the Vancouver money market. I I . DEALER INVENTORIES OF MONEY MARKET INSTRUMENTS IN VANCOUVER While l o c a l money market p a r t i c i p a n t s take p r i d e i n the r e c e n t growth experienced by the l o c a l market, they are not so s a t i s f i e d with the market as to be without complaints The complaint about Vancouver money market c o n d i t i o n s most f r e q u e n t l y v o i c e d by those p a r t i c i p a n t s i n t e r v i e w e d f o r t h i s study (among both dealer-and n o n - d e a l e r - p a r t i c i p a n t s ) was t h a t the i n v e n t o r i e s c u r r e n t l y maintained l o c a l l y by the dea l e r s are not s u f f i c i e n t to p r o v i d e adequate s e r v i c e . I t w i l l be r e c a l l e d from the d i s c u s s i o n o f the d e a l e r behaviour model i n Chapter I I t h a t d e a l e r i n v e n t o r i e s are only i n v o l v e d i n money market t r a n s a c t i o n s when the d e a l e r a c t s as a p r i n c i p a l . I t w i l l a l s o be r e c a l l e d t h a t when the d e a l e r ' s money market o p e r a t i o n s i n v o l v e the i n v e n t o r y i n g o f s e c u r i t i e s t h a t , compared to o p e r a t i o n s on an agency b a s i s , a g r e a t e r l e v e l o f d e a l e r investment i n money market opera-t i o n s i s i n v o l v e d . A l s o , the net cash b e n e f i t s are not j u s t c o n t i n g e n t upon the matching of i s s u e r s ' and i n v e s t o r s ' needs, but upon being able to buy and s e l l instruments to produce c a p i t a l g a i n s . S u f f i c i e n t c a p i t a l gains must be r e a l i z e d to make the investment i n such o p e r a t i o n s worthwhile. While some downside p r o t e c t i o n does e x i s t , the d i f f i c u l t y o f a c c u r a t e l y f o r e c a s t i n g i n t e r e s t r a t e changes with c o n c u r r e n t changes i n s e c u r i t y p r i c e s imparts a s u b s t a n t i a l degree of r i s k t o an investment by a d e a l e r i n money market instruments. Inasmuch as the f i n a n c i n g c o s t s o f such investments d i s p l a y c o n s i d e r -able v o l a t i l i t y and the r a t e s on o u t s t a n d i n g loans f o r such f i n a n c i n g are a u t o m a t i c a l l y a d j u s t e d to c o i n c i d e w i t h c u r r e n t r a t e s on such l o a n s , the p r o f i t a b i l i t y of such investments by a d e a l e r cannot be a c c u r a t e l y p r e d i c t e d . A d e a l e r may be prompted t o c a r r y i n v e n t o r y as a means o f encouraging g r e a t e r money market a c t i v i t y i n the f u t u r e by i s s u e r s and i n v e s t o r s which can be expected to r e s u l t i n net cash b e n e f i t s being r e c e i v e d by the d e a l e r . For the investment d e a l e r who i s c o n s i d e r i n g whether or not to maintain an i n v e n t o r y o f money market s e c u r i t i e s i n Vancouver or who has decided to maintain an i n v e n t o r y i n Van-couver but must determine the a p p r o p r i a t e l e v e l , there are fou r main f a c t o r s to be c o n s i d e r e d . The order i n which these f a c -t o r s are presented does not i n d i c a t e t h a t importance i s a t t a c h e d t o them i n t h a t o r d e r . 1. The d e a l e r must c a r e f u l l y e v a l u a t e the p o t e n t i a l o p p o r t u n i t i e s f o r p r o f i t a b l e o p e r a t i o n s and com-pare them to both the p o t e n t i a l o p p o r t u n i t i e s of othe r g e o g r a p h i c a l areas and to the p o t e n t i a l opp-o r t u n i t i e s o f a c t i v i t i e s i n v o l v i n g s e r v i c e s other than money market o p e r a t i o n s . 2 . A l s o to be c o n s i d e r e d i s the depth and breadth of the Vancouver money market s i n c e these f a c t o r s have a b e a r i n g on the l i q u i d i t y o f an i n v e n t o r y and thus on the ease with which an i n v e n t o r y can be l i q u i d a t e d e i t h e r t o take advantage of c a p i t a l gains o r to prevent c a p i t a l l o s s e s . 3. Both the a v a i l a b i l i t y and r e l i a b i l i t y o f loans f o r the f i n a n c i n g o f i n v e n t o r y must be c o n s i d e r e d s i n c e i n v e n t o r i e s o f money market instruments are supported by e x t e r n a l f i n a n c i n g . 4 . F i n a l l y , c o n s i d e r a t i o n must be given to the a l t e r -n a t i v e s to h o l d i n g i n v e n t o r y i n Vancouver. I f de-v i c e s e x i s t which a l l o w the same p r o f i t s t o be made whi l e h o l d i n g e i t h e r r i s k or investment a t lower l e v e l s , they would serve to d e t r a c t from the motiva-t i o n f o r the d e a l e r t o h o l d i n v e n t o r i e s i n Vancouver I t can be concluded t h a t high l e v e l s o f i n v e n t o r i e s would be maintained i n Vancouver i f the s i t u a t i o n c o u l d be d e s c r i b e d a 89 f o l l o w s : the best o p p o r t u n i t i e s f o r d e a l e r investment e x i s t i n Vancouver, the l o c a l money market has both depth and breadth, loans to f i n a n c e i n v e n t o r y are both a v a i l a b l e and r e l i a b l e , and no other a l t e r n a t i v e s to m a i n t a i n i n g a Van-couver i n v e n t o r y e x i s t . The t o t a l t r a d i n g i n v e n t o r i e s h e l d i n Vancouver have been estimated to be $52 m i l l i o n w i t h more than h a l f o f t h i s h e l d by the c h a r t e r e d banks and normal d a i l y money market t r a n s a c t i o n s i n the Vancouver market have been estimated at about $40 m i l l i o n . 1 While these data were based on market c o n d i t i o n s and a c t i v i t i e s i n the f a l l o f 1970, the money market personnel of the d e a l e r s i n t e r v i e w e d f o r t h i s study f e e l t h a t the c u r r e n t l e v e l s would be l i t t l e changed. Dealer i n v e n t o r i e s are c u r r e n t l y e s timated to be a l i t t l e over $20 m i l l i o n which would seem to be a low l e v e l c o n s i d e r i n g the d a i l y turnover o f about $40 m i l l i o n . T h i s t o t a l l e v e l o f Vancouver d e a l e r s ' i n v e n t o r i e s o f j u s t over $20 m i l l i o n serves as a p o i n t o f sharp c o n t r a s t between the money markets o f the Toronto and Montreal areas and t h a t of Vancouver. L o c a l money 2 market personnel who are f a m i l i a r w i t h the E a s t e r n market p o i n t out t h a t the E a s t e r n i n v e n t o r i e s o f any one of the f i f -t een jobbers would almost always exceed the t o t a l o f a l l ''"These are the estimates of G.H. Eaton and D.E. Bond, op. c i t . 2 Mr. David Holmes of A.E. Ames & Co. L t d . , can be c i t e d as one who has the experience i n the E a s t e r n market to lend c r e d i b i l i t y to t h i s statement. 90 d e a l e r i n v e n t o r i e s d o m i c i l e d i n Vancouver. Such a f a c t i s c i t e d by l o c a l money market personnel to s u b s t a n t i a t e t h e i r o p i n i o n t h a t i n many ways the Vancouver market can be com-pared to the E a s t e r n market o n l y i n h i g h l y q u a l i f i e d terms. I t i s not p o s s i b l e t o i n d i c a t e which of the above f o u r determinants of i n v e n t o r y management has been most r e -s p o n s i b l e f o r the low l e v e l s o f i n v e n t o r y maintained i n Van-couver. I t may be t h a t because the .Vancouver-based i n v e s t -ment i n money market instruments i s o n l y about one-tenth of t h a t i n the Toronto-Montreal area t h a t the l o c a l market sim-p l y does not o f f e r s u f f i c i e n t o p p o r t u n i t i e s t o support more than the small i n v e n t o r i e s o f o n l y f i v e d e a l e r s . Or, i t may be t h a t s i n c e the market i n Vancouver i s r e l a t i v e l y s m a l l and i s somewhat i s o l a t e d from the E a s t e r n market, t h a t the d i f f i -c u l t y o f l i q u i d a t i n g l a r g e i n v e n t o r i e s i n Vancouver may a c t as a s t r o n g d e t e r r e n t to the h o l d i n g o f such l e v e l s . There i s evidence t h a t the l a s t two f a c t o r s , the a v a i l a b i l i t y and r e l i a b i l i t y o f loans f o r i n v e n t o r y f i n a n c i n g and the e x i s t e n c e of o t h e r a l t e r n a t i v e s to i n v e n t o r i e s i n Vancouver may be ma-j o r f a c t o r s i n ca u s i n g low l e v e l s o f l o c a l i n v e n t o r y to be maintained. These two f a c t o r s w i l l be d i s c u s s e d below. F i n a n c i n g f o r Dealer I n v e n t o r i e s As was p o i n t e d out i n a p r e v i o u s s e c t i o n d e a l i n g w i t h the v a r i o u s instruments i n v o l v e d i n the money market, loans to investment d e a l e r s are e s s e n t i a l to the workings of such a market i n which investment d e a l e r s p l a y a c e n t r a l r o l e . T h i s p o i n t i s most e m p h a t i c a l l y i n d i c a t e d by the p r o v i s i o n o f l e n d e r of l a s t r e s o r t f a c i l i t i e s p r o v i d e d to the d e a l e r s , which are d e s i g n a t e d as money market j o b b e r s , by the Bank of Canada; f a c i l i t i e s which, p r i o r to 1953, were a f f o r d e d by the Bank of Canada o n l y to the c h a r t e r e d banks. The d a i l y o p e r a t i o n a l f i n a n c i n g of d e a l e r s ' i n v e n t o r -i e s , however, i s f a c i l i t a t e d by day-loans to d e a l e r s by the c h a r t e r e d banks and c a l l loans to d e a l e r s by c h a r t e r e d banks, f i n a n c i a l i n s t i t u t i o n s and n o n - f i n a n c i a l i n s t i t u t i o n s . The day-to-day loans by the c h a r t e r e d banks o r i g i n a t e d i n A p r i l of 1954 a t the s u g g e s t i o n of the Bank of Canada. The c a l l l o a n became a common f i n a n c i n g d e v i c e s h o r t l y t h e r e a f t e r when the Bank of Canada urged the d e a l e r s to seek a d d i t i o n a l i n v e n t o r y f i n a n c i n g o u t s i d e the banking community. Such f i -anancing has been known as country banking and has p l a y e d an important p a r t i n the growth of the money market. Day-to-Day Loans Day-to-day loans from the c h a r t e r e d banks are secured by t r e a s u r y b i l l s , s h o r t - t e r m Government of Canada bonds, and bankers' acceptances and g e n e r a l l y are used to f i n a n c e the a c q u i s i t i o n by the d e a l e r s of these instruments f o r the purpose of m a i n t a i n i n g t r a d i n g i n v e n t o r i e s of such instruments. Day-to-day loans serve as a h i g h l y l i q u i d investment f o r the c h a r t e r e d banks and s i n c e they form p a r t of the banks' sec-ondary r e s e r v e s , they p r o v i d e the banks wi t h a simple means of a d j u s t i n g the l e v e l of t h e i r r e s e r v e s i n the c o n s t a n t process of l i q u i d i t y management. The aspect of f i n a n c i n g v i a day-to-day loans which has important r a m i f i c a t i o n s f o r the Vancouver money market i s t h a t a l l c h a r t e r e d banks t r e a t cash management as a cen-t r a l i z e d f u n c t i o n . T h i s means t h a t a l l cash management de-c i s i o n s and t h e r e f o r e a l l day-to-day loans are a d m i n i s t e r e d i n the head o f f i c e s of the c h a r t e r e d banks. Since the Bank of B r i t i s h Columbia i s the o n l y bank wi t h i t s head o f f i c e i n Vancouver, the i m p l i c a t i o n i s t h a t d e a l e r s i n Vancouver have onl y one l o c a l source of day-to-day l o a n s . The Bank of B r i t i s h Columbia has, of course, o n l y l i m i t e d funds which i t w i l l i n v e s t i n day loans (recent l e v e l s of day loans by the Bank of B r i t i s h Columbia have been approximately $3 m i l l i o n ) . The s i t u a t i o n i s f u r t h e r complicated by the f a c t t h a t a t h r e e -hour time d i f f e r e n c e e x i s t s between Vancouver and the E a s t e r n markets where the head o f f i c e s o f the other c h a r t e r e d banks are a l l l o c a t e d . Moreover, most o f ^ t h e money market t r a n s -a c t i o n s and day-to-day lo a n arrangements have taken p l a c e i n the E a s t e r n market by noon E a s t e r n time. I f a d e a l e r i s unable to get a day l o a n from the Bank of B r i t i s h Columbia due to i t s u n w i l l i n g n e s s to extend f u r t h e r c r e d i t i n t h i s form or i f the Bank of B r i t i s h Columbia has c a l l e d an o u t s t a n d i n g day l o a n , the r e s u l t s may be as f o l l o w s . In the f i r s t case i f the s e c u r i t y to be pledged i s i n the d e a l e r ' s head o f f i c e i n the E a s t or can be t r a n s f e r r e d there through the Bank o f Canada's f a c i l i t i e s (only t r e a s u r y b i l l s or Government of Canada bonds can be t r a n s f e r r e d by the Bank), the d e a l e r ' s head o f f i c e w i l l n e g o t i a t e a day l o a n i n the E a s t or i f t h i s i s not p o s s i b l e , r e c o u r s e may be had to the lender of l a s t r e s o r t f a c i l i t i e s o f the Bank o f Canada. 1 I f the s e c u r i t y i s i n Vancouver and cannot be t r a n s f e r r e d (bank-e r s ' acceptances) or i f the Vancouver branch o f f i c e of the investment d e a l e r wants to m a i n t a i n the l e v e l o f l o c a l i n v e n -t o r y , the other c h a r t e r e d banks re p r e s e n t e d i n Vancouver may be approached. I f the bank's head o f f i c e approves and has day money a v a i l a b l e , the day-to-day lo a n may be a u t h o r i z e d w i t h the s e c u r i t y to serve as c o l l a t e r a l being lodged w i t h the Vancouver branch o f the c h a r t e r e d bank. In the event t h a t t h i s procedure i s not s u c c e s s f u l i n o b t a i n i n g the nece-s s a r y f i n a n c i n g , the Vancouver agency of the Bank of Canada can p r o v i d e l e n d e r o f l a s t r e s o r t f a c i l i t i e s . The above methods of a c q u i r i n g f i n a n c i n g , whether they are c a r r i e d out by the d e a l e r i n Vancouver or i n the E a s t e i t h e r through the c h a r t e r e d banks or the Bank of Canada, are c o n d i t i o n a l upon "^Such f a c i l i t i e s became a v a i l a b l e on a l o c a l b a s i s to d e a l e r s i n Vancouver i n 196 8 when the Bank o f Canada brought a s e c u r i t y r e p r e s e n t a t i v e to i t s Vancouver agency. T h i s ac-t i o n was i n f a c t prompted by the commencement of o p e r a t i o n s by the Bank of B r i t i s h Columbia. such a c t i v i t i e s being undertaken p r i o r t o two o ' c l o c k Van-couver time s i n c e none of these f a c i l i t i e s are a v a i l a b l e a f t e r two o ' c l o c k , which i s f i v e o ' c l o c k i n the E a s t e r n time zone. In f a c t , access to E a s t e r n day money may be i m p o s s i b l e a f t e r ten o ' c l o c k Vancouver time which i s one o ' c l o c k i n the Toronto-Montreal time zone and by then most, i f not a l l , o f the cash management process and a s s o c i a t e d day l o a n a c t i v i t y o f the c h a r t e r e d banks w i l l have been completed. Since day-to-day loans can be c a l l e d by e i t h e r p a r t y to the l o a n up to twelve o ' c l o c k , i t would seem t h a t such a c t i o n by the Bank of B r i t i s h Columbia would i n e v i t a b l y l e a d to r e f i n a n c i n g d i f f i c u l t i e s on the p a r t o f the d e a l e r . T h i s f a c t i s , o f course, r e c o g n i z e d by the bank and i n order to prevent such d i f f i c u l t i e s i t makes the d e a l e r aware of i t s i n t e n t i o n to c a l l loans as f a r i n advance of the c a l l as i s f e a s i b l e . The complexity and u n c e r t a i n t i e s of i n v e n t o r y f i n a n -c i n g i n Vancouver by day loans as o u t l i n e d above c o u l d h a r d l y be expected to encourage the l o c a l maintenance of anything but minimal l e v e l s of i n v e n t o r i e s . Other i m p l i c a t i o n s of the Day-Loan F a c t o r In the E a s t e r n market where th e r e are many l e n d e r s i n c o m p e t i t i o n f o r the f i n a n c i n g needs of the investment d e a l e r community the investment d e a l e r enjoys a more fa v o u r a b l e b a r g a i n i n g p o s i t i o n than does h i s c o u n t e r p a r t i n the Vancouver l o c a t i o n . For i n s t a n c e , because e i g h t b a n k s 1 are i n v o l v e d i n p r o v i d i n g day-to-day loans i n the E a s t , the d e a l e r can move from bank to bank i n response to any <. l o w e r i n g o f i n t e r e s t r a t e s f o r such l o a n s . The banks are aware of the f a c t t h a t d e a l e r l o y a l t y i n the area of day money needs i s n o n - e x i s t e n t and t h a t a d e a l e r w i l l t e r m i -nate a l o a n and t r a n s f e r h i s c o l l a t e r a l to any o t h e r bank which o f f e r s any f i n a n c i n g c o s t advantages. From t h i s en-vironment has evolved a h i g h l y c o m p e t i t i v e s i t u a t i o n which r e s u l t s i n the r a p i d d i s s e m i n a t i o n of any change i n the r a t e s charged f o r day money. Due to the f a c t t h a t the o n l y l o c a l s u p p l i e r of day-2 to-day loans i n Vancouver i s the Bank of B r i t i s h Columbia, th e r e i s a much l e s s c o m p e t i t i v e s i t u a t i o n p r e v a i l i n g . Even at mid-day E a s t e r n time, day money may be d i f f i c u l t to arrange f o r an Eastern-based i n v e n t o r y . I t i s , as d e s c r i b e d above, a more complex procedure f o r a d e a l e r t o arrange E a s t e r n day loans f o r i n v e n t o r y l o c a t e d i n Vancouver. The r e s u l t i s t h a t the d e a l e r i n the Vancouver market has l i m i t e d The e i g h t banks p r o v i d i n g day-to-day loans i n the Eas-t e r n market a r e : Canadian I m p e r i a l Bank of Commerce, The Royal Bank of Canada, Bank o f M o n t r e a l , The Toronto-Dominion Bank,The Bank of Nova S c o t i a , Banque Canadienne N a t i o n a l e , La Banque P r o v i n c i a l e du Canada and the M e r c a n t i l e Bank of Canada. 2 Both the l o c a l investment d e a l e r s and the c h a r t e r e d banks confirmed t h a t there i s o n l y one source of day-to-day loans i n Vancouver. b a r g a i n i n g power and s i n c e the a l t e r n a t i v e may be the p e n a l t y r a t e s of the Bank of Canada's Purchase and Resale Agreement f a c i l i t i e s , the d e a l e r i s r e l u c t a n t to press too s t r o n g l y f o r lower day l o a n r a t e s even when E a s t e r n r a t e s have weakened. The r e s u l t i s t h a t d i s c r e p a n c i e s between the E a s t e r n and Van-couver markets of up to h a l f o f one per cent i n day l o a n r a t e s have o c c u r r e d when r a t e s have been f a l l i n g . The l a g has meant higher f i n a n c i n g c o s t s f o r the Vancouver i n v e n t o r -i e s o f d e a l e r s i n comparison to the c o s t s o f E a s t e r n i n v e n -t o r y f i n a n c i n g . In the course o f i n t e r v i e w s w i t h o f f i c i a l s o f the Bank of B r i t i s h Columbia they acknowledged t h e i r aware-ness of t h i s s i t u a t i o n but expressed the b e l i e f t h a t the t e m p o r a r i l y r e l a t i v e l y h i g h e r c o s t s are o f f s e t by the f a c t t h a t the l o c a l r a t e f o r day-to-day loans a l s o l a g s the E a s t e r n r a t e s when the r a t e s are r i s i n g . I t i s onl y d u r i n g p e r i o d s o f r a t h e r r a p i d changes i n these r a t e s t h a t any r a t e d i f f e r -e n t i a l has been i n evidence. C a l l Loans The remainder o f i n v e n t o r i e s o f money market i n s t r u -ments not f i n a n c e d by day-to-day loans (that i s a l l money market instruments except Government of Canada t r e a s u r y b i l l s , s h o rt-term Government of Canada bonds, and bankers' accep-tances) must be f i n a n c e d u s i n g the c a l l l o a n f a c i l i t i e s o f the c h a r t e r e d banks, f i n a n c i a l i n s t i t u t i o n s and n o n - f i n a n c i a l i n -s t i t u t i o n s . S ince the instruments used as c o l l a t e r a l f o r such 97 loans are of a h i g h e r r i s k c l a s s and are g e n e r a l l y l e s s l i q u i d than those s e c u r i n g day-to-day l o a n s , i n t e r e s t charges f o r c a l l loans are h i g h e r than those f o r day l o a n s . C a l l l o a n s , however, can be o b t a i n e d from a much wider range of souarces and t h e r e -f o r e the n e c e s s i t y of lender of l a s t r e s o r t f a c i l i t i e s which e x i s t s f o r day l o a n c o l l a t e r a l f i n a n c i n g has been o b v i a t e d as f a r as other money market instruments i s concerned. As i s the case w i t h day loan f i n a n c i n g o f i n v e n t o r i e s , the c a l l loan s i t u a t i o n i n Vancouver i s f a r from being as r e l i a b l e or as simple as t h a t which e x i s t s i n the E a s t . While a d e a l e r i n Toronto or Montreal can o b t a i n c a l l l o a n f i n a n c i n g from at l e a s t two hundred i n s t i t u t i o n s , the d e a l e r t r y i n g t o o b t a i n such funds i n Vancouver must r e l y on a mere handf u l of l e n d e r s . The most important of the few l o c a l sour-ces of c a l l loans are the Bank of B r i t i s h Columbia, Cominco L t d . , P l a c e r Development L t d . , Bank of Nova S c o t i a , and Royal T r u s t . While the s m a l l e r number of sources f o r c a l l loans can be seen as r e s t r i c t i n g the growth of d e a l e r i n v e n -t o r i e s due simply to the l i m i t e d funds a v a i l a b l e , i t a l s o has i m p l i c a t i o n s which make the s i t u a t i o n more complex and l e s s r e l i a b l e than t h a t of the E a s t . In the normal course of b u s i n e s s , a d e a l e r may have an o p p o r t u n i t y to s e l l some item from h i s i n v e n t o r y which he has pledged as c o l l a t e r a l f o r a c a l l l o a n . T h i s u s u a l l y p r e s e n t s no problem s i n c e the lender has agreed to allow the d e a l e r to s u b s t i t u t e other s e c u r i t i e s from h i s i n v e n t o r y i n the event such a need may a r i s e . The l e n d e r , however, has r e s t r i c t e d the s u b s t i t u t i o n s the d e a l e r may make to a s p e c i -f i e d l i s t o f s e c u r i t i e s and then o n l y up to c e r t a i n amounts f o r each of the approved s e c u r i t i e s . S p e c i f i c a t i o n of which s e c u r i t i e s may be s u b s t i t u t e d and the allowed p r o p o r t i o n s of the t o t a l of the s e c u r i t i e s pledged are a r r i v e d a t by the lender a f t e r an a n a l y s i s of a l l money market investment oppor-t u n i t i e s . The l i s t o f s p e c i f i c a t i o n s mentioned above should be the same as the approved l i s t of s h o r t - t e r m investments from which the investment manager of the l e n d i n g f i r m i s a b l e to make s e l e c t i o n s f o r the f i r m ' s s h o r t - t e r m investment p o r t f o l i o . For these l i s t s of approved s e c u r i t i e s to d i f f e r would be i r r a t i o n a l on the p a r t of the lender s i n c e i n the event o f d e f a u l t on a c a l l loan by a d e a l e r , the l e n d e r i n f a c t becomes an i n v e s t o r i n the c o l l a t e r a l pledged as s e c u r i t y f o r the loan which then would be claimed by the l e n d e r . When a d e a l e r ' s i n v e n t o r y i s l a r g e and he has c a l l loans o u t s t a n d i n g w i t h a l a r g e number of l e n d e r s , such as i s the case i n Toronto and M o n t r e a l , there i s l i t t l e reason to expect d i f f i c u l t y i n being a b l e to s u b s t i t u t e from i n v e n t o r y f o r any p a r t i c u l a r item. But, i n the Vancouver s i t u a t i o n , t here i s l e s s chance of approved l i s t s o v e r l a p p i n g enough s e c u r i t i e s to ensure t h a t s u b s t i t u t i o n can be c a r r i e d out when so few l e n d e r s are i n v o l v e d i n c a l l l o a n s . The r e s u l t of not being able to e f f e c t a s u b s t i t u t i o n i s t h a t the l o a n must be r e p a i d . T h i s the d e a l e r i s able to do s i n c e he i s s e l l i n g the item f o r which the c a l l loan (or a p o r t i o n of the t o t a l c a l l loan) was secured. But by t e r m i n a t i n g the l o a n , the d e a l e r i s r i s k i n g the i r e of the lender who had not expected to have to f i n d another investment o p p o r t u n i t y f o r h i s funds so soon. Or, w h i l e the lender may not be at a l l annoyed, h i s search f o r an investment o p p o r t u n i t y f o r the newly f r e e d funds may r e s u l t i n a c a l l l o a n to another d e a l e r and thus leave fewer funds a v a i l a b l e i n the f u t u r e f o r the d e a l e r un-able to e f f e c t a s u b s t i t u t i o n . I t can be seen from the above d i s c u s s i o n t h a t the i n -s t i t u t i o n a l s t a t e of a f f a i r s i n the Vancouver area i s not conducive to the maintenance of l a r g e d e a l e r i n v e n t o r i e s of those money market instruments which are normally f i n a n c e d by the use of c a l l l o a n f a c i l i t i e s . Devices P r o v i d i n g A l t e r n a t i v e s to Dealer Inventory There e x i s t f o u r d e v i c e s which f a c i l i t a t e the main-tenance o f low l e v e l s o f i n v e n t o r i e s by d e a l e r s ; l e t t e r s of undertaking, the i s s u e of notes by agents, the Bank of Canada t r a n s f e r s e r v i c e and the p r o v i s i o n of l o c a l l y - i s s u e d s e c u r i t i e s by d e a l e r s on an agency b a s i s . These d e v i c e s are o u t l i n e d below. 100 L e t t e r s of Undertaking To some i n v e s t o r s , i n l i e u of immediate d e l i v e r y of the instrument, the d e a l e r may be able to simply d e l i v e r (upon r e c e i p t of payment f o r the s e c u r i t y ) a l e t t e r o f under-t a k i n g which i s simply a w r i t t e n agreement to undertake de-l i v e r y of the p a r t i c u l a r s e c u r i t y as soon as p o s s i b l e from the l o c a t i o n i n which the i n v e n t o r y i s l o c a t e d . F r e q u e n t l y , the a c t u a l d e a l e r ' s l e t t e r of u ndertaking i s deemed un-necessary. The d e a l e r ' s v e r b a l commitment by telephone may be regarded as s u f f i c i e n t l y b i n d i n g . To the i n v e s t o r who i s u n w i l l i n g to accept a d e a l e r ' s l e t t e r of undertaking i n l i e u of the a c t u a l s e c u r i t y , another a l t e r n a t i v e does e x i s t . When a d e a l e r ' s l e t t e r i s regarded as unacceptable, r a t h e r than forego an investment o p p o r t u n i t y when the s e c u r i t i e s are not l o c a t e d i n Vancouver, the i n v e s -t o r may be w i l l i n g to accept a bank l e t t e r o f u n d e r t a k i n g . For a fee amounting to $40 per m i l l i o n d o l l a r s worth of se-c u r i t i e s i n v o l v e d , a c h a r t e r e d bank w i l l d e l i v e r a l e t t e r t o the i n v e s t o r i n which i t assumes the r e s p o n s i b i l i t y of d e l i -v e r i n g the p a r t i c u l a r s e c u r i t i e s . The l e t t e r s t a t e s t h a t the s e c u r i t i e s are being h e l d by the bank f o r the i n v e s t o r and t h a t they w i l l be d e l i v e r e d as soon as p o s s i b l e by the bank to the i n v e s t o r or to a l o c a t i o n or agent designated by the i n v e s t o r . Before such a l e t t e r can be i s s u e d by the bank the s e c u r i t i e s must be d e l i v e r e d to the bank by the d e a l e r . 1 0 1 The bank l e t t e r of undertaking has been more wid e l y accepted l o c a l l y than has the d e a l e r ' s l e t t e r s i n c e the Canadian char-t e r e d banks are viewed as having l i t t l e or no d e f a u l t r i s k o r at l e a s t much l e s s than any p a r t i c u l a r investment d e a l e r . Issue o f Notes by Agents In order to f a c i l i t a t e the wide g e o g r a p h i c a l d i s p e r s i o n of t h e i r instruments, some i s s u e r s make arrangements w i t h c h a r t e r e d banks and t r u s t companies to i s s u e t h e i r instruments i n c i t i e s o t h e r than the c o r p o r a t i o n ' s head o f f i c e l o c a t i o n . In t h i s way a borrower i s not denied access to the funds o f a lender who makes an o f f e r c o n t i n g e n t upon h i s being able to take r e c e i p t of the a c t u a l instrument on the same day. T h i s s i t u a t i o n c o u l d and does a r i s e i n the case o f a d e a l e r not having any of the p a r t i c u l a r s e c u r i t i e s i n h i s i n v e n t o r y i n the c i t y i n which the le n d e r i s l o c a t e d when the head o f f i c e of the borrower i s l o c a t e d i n another c i t y . I f the le n d e r were u n w i l l i n g to accept the d e a l e r ' s l e t t e r of undertaking or a bank l e t t e r o f un d e r t a k i n g , the d e a l c o u l d not be c l o s e d u n l e s s the i s s u e r had made arrangements f o r an agent i n the le n d e r ' s l o c a t i o n to i s s u e the instruments o f i n t e r e s t . To make such an arrangement an i s s u e r simply approaches the c h a r t e r e d bank or t r u s t company he wants to a c t as h i s i s s u i n g agent and n e g o t i a t e s the terms and c o n d i t i o n s . A fee 102 i s charged by the agent and c u r r e n t l y ranges from f i v e to ten d o l l a r s f o r each instrument i s s u e d . The fee does not vary i n r e l a t i o n to the denomination of a p a r t i c u l a r note. The i s s u -i n g c o r p o r a t i o n must p r o v i d e the agent with an adequate supply of the notes. As a r e s u l t of t h i s procedure, s h o r t - t e r m i n v e s t o r s i n the Vancouver area can take immediate p o s s e s s i o n o f many short-t e r m instruments i s s u e d by borrowers i n l o c a t i o n s o t h e r than Vancouver even though such instruments may not be i n l o c a l d e a l e r i n v e n t o r i e s at any p a r t i c u l a r time. Among ex-amples of borrowers not l o c a t e d i n Vancouver who use t h i s de-v i c e are the Pr o v i n c e o f Manitoba, the Pr o v i n c e o f Saskatchewan (both i s s u i n g p r o v i n c i a l t r e a s u r y - b i l l s ) , F i r e s t o n e T i r e and Rubber Company o f Canada L i m i t e d , I n t e r n a t i o n a l N i c k e l Company of Canada L i m i t e d , Honeywell Holdings L i m i t e d , and Transameri-ca F i n a n c i a l C o r p o r a t i o n of Canada L i m i t e d . Among Vancouver-based borrowers who use t h i s d e v i c e f o r i s s u i n g notes i n the E a s t e r n c i t i e s are MacMillan B l o e d e l L i m i t e d and B r i t i s h Columbia Telephone Company. The Bank of Canada T r a n s f e r S e r v i c e Another d e v i c e which f a c i l i t a t e s the low l e v e l of d e a l e r i n v e n t o r y i s the Bank of Canada t r a n s f e r s e r v i c e . In the Investment D e a l e r ' s A s s o c i a t i o n B r i e f to The Royal Commi-s s i o n on Banking and Finance of June 1962 t h i s f a c i l i t y i s 103 described''" as one which has g r e a t l y a s s i s t e d the d e a l e r s i n doing b u s i n e s s o u t s i d e o f the Toronto and Montreal a r e a s . The t r a n s f e r s e r v i c e i s i n f a c t an arrangement whereby the Bank of Canada r e l e a s e s bonds at no c o s t to the d e a l e r a t any one of the Bank's agencies across Canada. Under t h i s arrangement, a f t e r January 1957, any d e a l e r c o u l d hand i n Government of Canada t r e a s u r y b i l l s or short-term Government of Canada bonds at any agency of the Bank of Canada, which would arrange to r e l e a s e the same s e c u r i t i e s the same day at any other agency of the Bank. The P r o v i s i o n of L o c a l l y - I s s u e d S e c u r i t i e s by Dea l e r s  On an Agency B a s i s J u s t as the issuance of notes by E a s t e r n o r g a n i z a t i o n s through agents i n Vancouver obviates the need f o r the l o c a l d e a l e r to c a r r y such instruments i n l o c a l i n v e n t o r i e s , the p r a c t i c e of Vancouver i s s u e r s o f i s s u i n g instruments on de-mand or on s h o r t n o t i c e has a s i m i l a r e f f e c t . The i n c e n t i v e s f o r a d e a l e r to handle such l o c a l i s s u e s on an agency b a s i s are f i r s t , t h a t such t r a n s a c t i o n s do not r e q u i r e an i n c r e a s e i n the d e a l e r ' s investment i n i n v e n t o r i e s and second, t h a t the a t t e n t i o n given to such an i s s u e r may i n c r e a s e the l i k e l i -hood of i n c r e a s e d f u t u r e b u s i n e s s f o r the d e a l e r from the i s s u e r . ''"Investment Dealer's A s s o c i a t i o n B r i e f to the Royal  Commission on Banking and Finan c e , Toronto, June, 1962, Appendix G, pp. 2-3. 104 In summary i t appears t h a t the low l e v e l s o f d e a l e r i n v e n t o r i e s i n Vancouver are the r e s u l t of more a t t r a c t i v e o p p o r t u n i t i e s f o r d e a l e r investment i n ot h e r geographic and/ or s e r v i c e a r e a s , the adverse impact of the r e l a t i v e l y s m a l l money market i n Vancouver on the l i q u i d i t y o f money market i n v e n t o r i e s , the l i m i t e d a v a i l a b i l i t y and r e l i a b i l i t y o f loans f o r i n v e n t o r y f i n a n c i n g i n Vancouver, and f i n a l l y , the e x i s t e n c e of d e v i c e s such as l e t t e r s of un d e r t a k i n g , the i s s u e o f instruments by agents, the t r a n s f e r s e r v i c e o f the Bank of Canada, and the p r o v i s i o n of l o c a l l y - i s s u e d s e c u r i -t i e s by d e a l e r s on an agency b a s i s . The I m p l i c a t i o n s of Low Dealer I n v e n t o r i e s f o r Vancouver I n v e s t o r s Inadequacies r e g a r d i n g d e a l e r i n v e n t o r i e s may be of two types; f i r s t , the i n a b i l i t y to supply more than a sma l l amount of any p a r t i c u l a r i s s u e demanded by an i n v e s t o r ; second, the i n a b i l i t y to supply a wide range of instruments w i t h regard to i s s u e r , r i s k l e v e l , m a t u r i t y , c a l l a b i l i t y , m a r k e t a b i l i t y , and y i e l d . While these two types of inade-quacies are concepts which o v e r l a p , i t i s the second which has the g r e a t e r importance to l o c a l i n v e s t o r s s i n c e i t i s t h i s type o f inadequacy which r e s t r i c t s d i v e r s i f i c a t i o n of an investment p o r t f o l i o and p r e s e n t s d i f f i c u l t i e s i n the matching o f cash flows t o investments. The f i r s t type of shortcoming, t h a t o n l y small amounts of a p a r t i c u l a r i s s u e may be h e l d i n i n v e n t o r i e s by d e a l e r s l o c a l l y , seems not to be a s e r i o u s problem. T h i s i s because the t o t a l investment i n money market instruments i s not l a r g e . Since the t o t a l demand by Vancouver i n v e s t o r s f o r s h o r t - t e r m investments i s r e l a t i v e l y s m a l l , assuming some d i v e r s i t y of i n t e r e s t the demand f o r a p a r t i c u l a r i s s u e w i l l be r e l a t i v e l y s m a l l and t h e r e f o r e , l a r g e q u a n t i t i e s of p a r t i c u l a r i s s u e s i n l o c a l i n v e n t o r i e s would not be necessary. There e x i s t s the d e s i r e , on the p a r t of some l o c a l i n -v e s t o r s , f o r a wider range o f c h o i c e of instruments; t h a t i s , f o r a market wi t h g r e a t e r breadth. The d e s i r e f o r a wider range of c h o i c e i s c o n s i s t e n t with the i n v e s t o r behaviour model inasmuch as, w i t h a wider s e l e c t i o n o f investment opp-o r t u n i t i e s a v a i l a b l e , the i n v e s t o r w i l l l i k e l y be able to o b t a i n an investment p o r t f o l i o more n e a r l y o p t i m a l . However, the f a c t t h a t the d e a l e r s have the p a r t i c u l a r investment v e h i c l e d e s i r e d by the i n v e s t o r i n i n v e n t o r y i n Toronto or Montreal r a t h e r than i n Vancouver i s regarded as s u f f i c i e n t by some i n v e s t o r s . To these i n v e s t o r s , i n l i e u of immediate d e l i v e r y of the instrument, the d e a l e r may be a b l e to simply d e l i v e r (upon r e c e i p t of payment f o r the s e c u r i t y ) a l e t t e r o f undertaking which i s simply a w r i t t e n agreement to under-take d e l i v e r y of the p a r t i c u l a r s e c u r i t y as soon as p o s s i b l e from the l o c a t i o n i n which the i n v e n t o r y i s l o c a t e d . 106 Understandably, to some i n v e s t o r s a d e a l e r ' s l e t t e r o f undertaking i s not regarded as a s u i t a b l e means of overcoming the problem of i n s u f f i c i e n t l o c a l i n v e n t o r i e s . For these i n -v e s t o r s , the acceptance of a d e a l e r ' s l e t t e r o f undertaking i s r e c o g n i z e d as adding a f u r t h e r measure of r i s k to the i n -vestment. That i s , the i n v e s t o r faces the r i s k not onl y t h a t the i s s u e r o f the s e c u r i t y being purchased w i l l d e f a u l t , but a l s o t h a t the d e a l e r who s o l d him the s e c u r i t y w i l l f a i l to honour the commitment to d e l i v e r the s e c u r i t y as promised i n the l e t t e r of undertaking and may be unable or u n w i l l i n g to reimburse the i n v e s t o r f o r h i s payment f o r the s e c u r i t y and/or the r e s u l t a n t l o s s of i n t e r e s t . An i n v e s t o r who i s u n w i l l i n g to accept a d e a l e r ' s l e t t e r i s a c t i n g on the b a s i s of the f o l l o w i n g premises. The promised r e t u r n on an investment ( i n the case of d e f a u l t - f r e e s e c u r i t i e s such as Government of Canada t r e a s u r y b i l l s and bonds h e l d to m a t u r i t y , the promised and expected r e t u r n s w i l l be i d e n t i c a l ) i s j u s t s u f f i c i e n t to compensate the i n v e s t o r f o r h i s t e m p o r a r i l y being d e p r i v e d of h i s c a p i t a l and f o r the r i s k being borne by the i n v e s t o r t h a t the borrower w i l l de-f a u l t ( d e f a u l t meaning t h a t payments of i n t e r e s t and/or p r i n c i p a l are not made by the borrower as promised). The promised y i e l d o f an investment i s the same whether or not the d e a l e r i s ab l e to d e l i v e r i t immediately. In the event of the d e a l e r ' s encountering f i n a n c i a l or a d m i n i s t r a t i v e d i f f i c u l t i e s , the d e a l e r may be unable or u n w i l l i n g t o de-l i v e r the s e c u r i t y f o r which the i n v e s t o r has p a i d when the arrangement of a d e a l e r s l e t t e r o f undertaking has been used and the i n v e s t o r may l o s e both p r i n c i p a l and the expected i n -t e r e s t income. Those i n v e s t o r s who accept a d e a l e r ' s l e t t e r must bear the r i s k o f the l o s s o f the amount p a i d t o the d e a l e r i n the event the d e a l e r f a i l s to honour h i s commitment to d e l i v e r the s e c u r i t y . T h i s l o s s would be o f f s e t by any compensation f o r the l o s s as obtained through c o u r t a c t i o n or from a r e c e i v e r i n the event of l i q u i d a t i o n of the d e a l -e r . T h i s r i s k i s above and beyond t h a t investment r i s k borne by the i n v e s t o r even i f the s e c u r i t y i s d e l i v e r e d by the d e a l e r as agreed,that i s the r i s k of d e f a u l t by the i s s u e r . An i n v e s t o r who i s u n w i l l i n g to accept a d e a l e r ' s l e t t e r , then, regards the promised y i e l d on the investment as not being s u f f i c i e n t to f u l l y compensate f o r the i n v e s t -ment r i s k p l u s the d e a l e r r i s k . For some i n v e s t o r s the q u e s t i o n o f whether a d e a l e r ' s l e t t e r or a bank l e t t e r or the immediate d e l i v e r y o f the ac-t u a l s e c u r i t i e s i s the ac c e p t a b l e means o f doing business may be important. T h i s i s so because i n some cases none of these occur; the i n v e s t o r merely leaves the s e c u r i t y i n safekeeping w i t h the d e a l e r and never a c t u a l l y takes p o s s e s s i o n (nor does h i s agent take possession) o f the s e c u r i t y . The im-p l i c a t i o n s f o r the r i s k borne by the i n v e s t o r (unless the s e c u r i t y i s f u l l y r e g i s t e r e d ) are much the same as i s the case f o r d e a l e r s ' l e t t e r s o f undertaking as o u t l i n e d above, except t h a t i n t h i s case the a d d i t i o n a l d e a l e r r i s k i s ex-tended over the e n t i r e d u r a t i o n of the investment. Both o f these p r a c t i c e s have the e f f e c t o f s h i f t i n g the instruments i n v o l v e d i n t o a hig h e r l e v e l of r i s k without any a d d i t i o n a l compensation. Of those Vancouver money market len d e r s or i n v e s t o r s i n t e r v i e w e d , some were found to accept d e a l e r ' s l e t t e r s as a matter o f course, o t h e r s w i l l accept o n l y bank l e t t e r s , w h i l e some w i l l accept e i t h e r on o n l y r a r e o c c a s i o n s . For example, the Bank of B r i t i s h Columbia has e x p l i c i t l y ex-pressed to the investment d e a l e r s t h a t a s i d e from the r i s k i m p l i c a t i o n s i n v o l v e d , i t s p o l i c y o f demanding normal d e l i -very o f s e c u r i t i e s except i n o n l y unusual circumstances i s a l s o designed to encourage l a r g e r d e a l e r i n v e n t o r i e s i n order t o promote the development of the l o c a l money market. For a l o c a l i n v e s t o r to achieve an op t i m a l s h o r t - t e r m p o r t f o l i o the breadth or range of a v a i l a b l e a l t e r n a t i v e i n -vestment o p p o r t u n i t i e s i n the Vancouver market should be as wide as t h a t o f the E a s t e r n market. Complete i n f o r m a t i o n o f 109 a v a i l a b l e o p p o r t u n i t i e s i s r e q u i r e d f o r such an o p t i m a l p o r t -f o l i o to be achieved. When a l o c a l i n v e s t o r r e q u i r e s normal d e l i v e r y the d e a l e r , i n making an o f f e r i n g of s e c u r i t i e s , w i l l not i n c l u d e any instruments which would r e q u i r e delayed d e l i v e r y . T h i s s c r e e n i n g process i n the composition d f o f f e r -ings would narrow the range of a l t e r n a t i v e o p p o r t u n i t i e s a v a i l a b l e to the i n v e s t o r s i n c e the o f f e r i n g would i n c l u d e o n l y those instruments h e l d i n l o c a l i n v e n t o r i e s , the i s s u e s of E a s t e r n o r g a n i z a t i o n s a v a i l a b l e through l o c a l agents, se-c u r i t i e s which are h e l d i n the d e a l e r ' s i n v e n t o r i e s i n Toron-to or Montreal and can be t r a n s f e r r e d to Vancouver v i a the Bank of Canada and the s e c u r i t i e s of Vancouver-based i s s u e r s which can be secured on s h o r t n o t i c e . Such s c r e e n i n g by a d e a l e r c o n t r i b u t e s to the s u b o p t i m i z a t i o n of i n v e s t o r s ' s h o r t -term p o r t f o l i o s . The I m p l i c a t i o n s of Low Dealer I n v e n t o r i e s  f o r Vancouver I s s u e r s The l o c a l i s s u e r of money market instruments seems to be the main b e n e f i c i a r y of the p r e v a i l i n g low l e v e l of d e a l e r i n v e n t o r i e s . His i s s u e p r o v i d e s the market wi t h a r e a d i l y a-v a i l a b l e investment v e h i c l e and s i n c e i t i s o f t e n i s s u e d on demand, such a s e c u r i t y appeals to the l o c a l i n v e s t o r who r e -q u i r e s immediate d e l i v e r y . Since such s e c u r i t i e s are a v a i l -a b l e on s h o r t n o t i c e , i n v e n t o r y i n g of the i s s u e by a d e a l e r i s not r e q u i r e d . The f a c t t h a t such s e c u r i t i e s can be handled on an agency b a s i s by a d e a l e r and the appeal of these instruments to l o c a l i n v e s t o r s r e q u i r i n g normal d e l i v e r y ensure a l o c a l i s s u e r o f r e c e i v i n g top-notch s e r v i c e from the investment d e a l e r . The i s s u e r ' s borrowing v i a the money market i s thus made e a s i e r which helps him i n h i s attempt to minimize h i s c o s t of short - t e r m c a p i t a l . T h i s completes the d i s c u s s i o n o f the r e c e n t growth of the Vancouver money market and i t s major i m p e r f e c t i o n as o u t l i n e d i n the i n t r o d u c t i o n to t h i s c h a p ter. I l l CHAPTER V ADDITIONAL PECULIARITIES OF THE VANCOUVER MONEY MARKET Thi s chapter completes the d e s c r i p t i o n of the Van-couver money market by o u t l i n i n g the remaining major p e c u l a r i -t i e s which are man i f e s t i n t h a t market. Part I p o i n t s out the low l e v e l of autonomy granted by the head o f f i c e s of i n -vestment d e a l e r s to t h e i r Vancouver money market personnel and i n d i c a t e s the i m p l i c a t i o n s o f t h i s l a c k of autonomy to l o c a l market p a r t i c i p a n t s . P a r t I I i s a d i s c u s s i o n of the i m p l i c a t i o n s of the time zone d i f f e r e n t i a l between the Van-couver and the E a s t e r n markets. P a r t I I I concludes the chap-t e r with a d i s c u s s i o n o f the r e l a t i v e l a c k of s o p h i s t i c a t i o n e x h i b i t e d by l o c a l i n v e s t o r s and l o c a l borrowers i n t h e i r r e -s p e c t i v e money market a c t i v i t i e s . Furthermore, P a r t I I I su-ggests t h a t the r e s p o n s i b i l i t y f o r t h i s l a c k of s o p h i s t i c a t i o n r e s t s with the l o c a l investment d e a l e r community. I. DEALERS 1 LACK OF LOCAL AUTONOMY A complaint f r e q u e n t l y v o i c e d about l o c a l money market c o n d i t i o n s by i n v e s t o r s and borrowers i s t h a t l o c a l d e a l e r p e r s o n n e l l a c k autonomy i n decision-making r e g a r d i n g money market o p e r a t i o n s . 112 Since the l o c a l d e a l e r has l i m i t e d i n v e n t o r i e s he i s o f t e n f o r c e d to make o f f e r s t o i n v e s t o r s from head o f f i c e i n v e n t o r i e s . T h i s means t h a t the o f f e r to the c l i e n t must be delayed u n t i l the d e a l e r ' s head o f f i c e i s contacted t o a s c e r t a i n not o n l y what instruments are a v a i l a b l e , but a l s o the r e l e v a n t r a t e s . The delay i n v o l v e d may be onl y a matter of a few minutes or i t may be o v e r n i g h t i f the request f o r an o f f e r i n g i s not r e c e i v e d l o c a l l y before two o'c l o c k a t which time E a s t e r n head o f f i c e s are c l o s e d . The l a c k of l o c a l autonomy a l s o a f f e c t s the a b i l i t y of a l o c a l d e a l e r to respond to an o f f e r from a l o c a l i n v e s t o r or i n s t i t u t i o n t o s e l l a money market instrument. The d e a l e r w i l l e n t e r a b i d f o r the s e c u r i t y i f he f e e l s t h a t he can r e a d i l y s e l l i t to another l o c a l i n v e s t o r or f o r h i s t r a d i n g i n v e n t o r y i f he f e e l s t h a t demand f o r the s e c u r i t y w i l l e x i s t i n the near f u t u r e . T h i s s i t u a t i o n c l o s e l y p a r a l l e l s t h a t of a request f o r b i d s f o r s e c u r i t i e s from a l o c a l i s s u e r of money market s e c u r i t i e s . I f the l o c a l d e a l e r i s faced w i t h making a purchase of e i t h e r of these types f o r h i s own in v e n -t o r y , he i s f r e e t o do so without c o n s u l t i n g h i s s u p e r i o r i n the head o f f i c e o n l y i f the amount i n v o l v e d i s below a s p e c i -f i e d s i z e or an u n s p e c i f i e d but w e l l understood s i z e and i f he i s able t o o b t a i n l o c a l f i n a n c i n g f o r such a d d i t i o n a l i n -ventory. In the event t h a t the s i z e i n v o l v e d i s above l o c a l l i m i t s o r f i n a n c i n g l o c a l l y i s not p o s s i b l e , the l o c a l money 113 market pe r s o n n e l must c o n t a c t e i t h e r the p a r t n e r o r d i r e c t o r i n charge of the f i r m ' s money market o p e r a t i o n s who i s l o c a -ted i n the head o f f i c e . While the de l a y caused from having t o c o n t a c t the money market manager a r i s e s from the n e c e s s i t y o f u s i n g t e l e t y p e or telephone i n s t e a d of the p e r s o n a l c o n t a c t a v a i l -able i n the E a s t e r n markets, there are other f a c t o r s which may i n c r e a s e the delay and thus compound the problems caused by such d e l a y s . F i r s t , there i s the time d i f f e r e n c e . From nine o ' c l o c k to eleven o ' c l o c k Vancouver time, the manager i n the E a s t w i l l l i k e l y be a t lunch and no r e p l y to the l o c a l p e rsonnel's query w i l l be forthcoming u n t i l h i s r e t u r n . F u r t h e r to t h i s , i f the request i s not made bef o r e two o'c l o c k Vancouver time, the manager i n the Ea s t has l e f t the o f f i c e f o r the day. Second, while the amount i n v o l v e d may be too l a r g e f o r the l o c a l p e r s onnel to make a d e c i s i o n , i t may be q u i t e s m a l l i n comparison to the t r a n s a c t i o n s which are normal i n the E a s t e r n market. Since the manager i n the E a s t may be i n v o l v e d i n making d e c i s i o n s i n v o l v i n g amounts many times g r e a t e r than t h a t which the Vancouver branch i s concerned w i t h , he may not give i t the prompt a t t e n t i o n which the l o c a l p e r s o n n e l would d e s i r e . I t i s seen, then, t h a t the l a c k of l o c a l autonomy can produce d e l a y s i n s e r v i c i n g l o c a l p a r t i c i p a n t s due to the need f o r c o n s u l t a t i o n , the d i f f e r e n c e i n time zones, and the 114 g e n e r a l l y s m a l l e r s i z e of t r a n s a c t i o n s i n the l o c a l market. When such f a c t o r s cause a l o c a l d e a l e r to delay the p r e s e n t a t i o n of an o f f e r i n g of a v a i l a b l e s e c u r i t i e s as r e -quested by an i n v e s t o r w i t h funds to be i n v e s t e d i n the money market, the i n v e s t o r i s being r e s t r i c t e d i n h i s attempt to o b t a i n an o p t i m a l short-term p o r t f o l i o . While h i s funds can be banked over n i g h t , the r e t u r n r e c e i v e d w i l l be l e s s than t h a t which would have been r e a l i z e d had the i n v e s t o r been able to r e a d i l y purchase the money market instruments of h i s c h o i c e . The i n v e s t o r i s a l s o a f f e c t e d by d e l a y s on the d e a l e r ' s p a r t i n h i s b i d d i n g f o r instruments o f f e r e d by the i n v e s t o r when the i n v e s t o r wishes to terminate an investment. Since t h i s i s more p r e v a l e n t when s u b s t a n t i a l amounts are i n -v o l v e d , the i n v e s t o r c o n s i d e r i n g the purchase of a l a r g e i s s u e must r e c o g n i z e these p o t e n t i a l delays as r e d u c i n g an instrument's l i q u i d i t y and i n c a l c u l a t i n g the NPV of the i n -vestment, must reduce the c e r t a i n t y e q u i v a l e n t c o e f f i c i e n t s a c c o r d i n g l y . Delays by a d e a l e r i n making b i d s f o r s e c u r i t i e s o f f e r e d by an i s s u e r may r e s u l t i n higher c o s t s of short-term c a p i t a l f o r the i s s u e r or perhaps i n the i s s u e r being tempor-a r i l y unable to o b t a i n funds. The h i g h e r c o s t s of short-term c a p i t a l would be the r e s u l t i f more expensive bank loans were u t i l i z e d to p r o v i d e i n t e r i m funds u n t i l the d e a l e r prepared a b i d . For the d e a l e r , the l i m i t e d l o c a l autonomy permits 115 the head o f f i c e to c o n t r o l the l e v e l of investment which the f i r m makes i n i t s t o t a l money market o p e r a t i o n s . T h i s c e n t -r a l i z a t i o n o f d e c i s i o n making permits the f i r m ' s money market manager to compare the p o t e n t i a l p r o f i t a b i l i t y of E a s t e r n and Vancouver money market investments. The manager must judge the importance of the g r e a t e r l i q u i d i t y a f f o r d e d by the l a r -ger E a s t e r n market i n d e c i d i n g which of the a v a i l a b l e a l t e r n a -t i v e E a s t e r n and Vancouver investments to make. Furthermore, the g r e a t e r s e l e c t i o n of s u p p l i e r s of c a l l and day loans i n the E a s t may permit the manager i n the. head o f f i c e to o b t a i n lower r a t e s on such loans than c o u l d be obtained i n Vancouver which i n c r e a s e s an investment's p r o f i t a b i l i t y by l o w e r i n g the f i r m ' s c o s t of c a p i t a l . C l e a r l y , the l a c k of autonomy on the p a r t of l o c a l d e a l e r s i s a p e c u l i a r i t y of the Vancouver money market which i s of importance to a l l three types of p a r t i c i p a n t s i n v o l v e d i n the l o c a l market. I I . IMPLICATIONS OF TIME ZONE DIFFERENTIALS Mention has been made of the d i f f e r e n t time zones i n which the Toronto-Montreal and Vancouver money markets are l o c a t e d . Canada i s d i v i d e d i n t o s i x time zones with a t o t a l of four and one h a l f hours te m p o r a l l y s e p a r a t i n g Newfoundland 116 and B r i t i s h Columbia."1' The three hour time d i f f e r e n c e between the Toronto-Montreal market and t h a t of Vancouver means t h a t by the time t h a t most market t r a n s a c t i o n s have been completed i n the E a s t , t h a t i s a t noon E a s t e r n time, business hours i n Vancouver are j u s t b e g i n n i n g . A l s o , some three business hours remain i n the Vancouver market a f t e r E a s t e r n c l o s i n g time. In the l i g h t of these circumstances, i t would seem r a t i o n a l to expect t h a t the two markets would be independent to a c o n s i d e r a b l e e x t e n t . Often c i t e d as evidence t h a t the Vancouver money market i s not merely an o f f s h o o t o r branch of the Toronto-Montreal market i s the f a c t t h a t money market t r a n s -a c t i o n s occur i n Vancouver a f t e r the bulk o f the E a s t e r n d a i l y market a c t i v i t y has o c c u r r e d and even a f t e r the E a s t e r n o f f i c e s are c l o s e d . Such l o c a l t r a n s a c t i o n s i n v o l v e both l o c a l i s s u e s and those of E a s t e r n concerns and may even i n v o l v e f o r e i g n par-t i c i p a n t s . But much of the Vancouver market a c t i v i t y c o i n c i d e s w i t h and i n v o l v e s the Toronto-Montreal market. When funds be-come a v a i l a b l e f o r investment i n money market instruments e i t h e r a f t e r the E a s t e r n market i s c l o s e d o r even e a r l i e r but when most a c t i v i t y has ceased i n t h a t market and s u i t a b l e instruments are not a v a i l a b l e i n Vancouver i n v e n t o r i e s , the common procedure i s f o r the funds to be banked l o c a l l y o v e r n i g h t and i n v e s t e d i n the The s i x time zones of North America are d e p i c t e d g r a p h i c a l l y on the map o f F i g u r e 6 below. FIGURE 6 NORTH AMERICAN TIME ZONES 118 a p p r o p r i a t e s e c u r i t y a v a i l a b l e i n the E a s t the next morning. Lodging the funds o v e r n i g h t i n a bank prevents the i n v e s t o r from f a i l i n g to o b t a i n some r e t u r n on the funds f o r the day. To ensure t h a t such funds are p l a c e d i n the appro-p r i a t e s e c u r i t i e s without f u r t h e r d e l a y , the l o c a l d e a l e r w i l l a r r i v e at h i s o f f i c e around e i g h t o'clock the next mor-n i n g while the E a s t e r n market i s s t i l l a c t i v e and the money market personnel i n h i s head o f f i c e are a l l a v a i l a b l e to a s s i s t him i n p l a c i n g the funds. The i n t e r a c t i o n of the two money markets i s i n f a c t q u i t e e x t e n s i v e s i n c e a g r e a t d e a l of l o c a l investment i n v o l v e s t h i s procedure. The d i f f e r e n c e i n time can l e a d to d i f f i c u l t i e s when a Western branch t r i e s to c o n t a c t the head o f f i c e money market manager. He may have l e f t f o r lunch or may have l e f t f o r the day wh i l e business hours i n Vancouver continue and t h i s may mean o v e r n i g h t postponement of a f i n a n c i n g or i n v e s t -ment d e c i s i o n by a Vancouver p a r t i c i p a n t . Western i n v e n t o r y problems are a l s o made more com-p l i c a t e d by the time d i f f e r e n c e . I t i s not p o s s i b l e to make t r a n s f e r s from Toronto o r Montreal to Vancouver through the Bank of Canada a f t e r f i v e o ' c l o c k E a s t e r n time which i s two o' c l o c k Vancouver time. The same time c o n s t r a i n t s apply to the arrangement of day-to-day loans at banks other than the Bank of B r i t i s h Columbia and the arrangement of e i t h e r bank l e t t e r s o f undertaking or d e a l e r ' s l e t t e r of unde r t a k i n g . 119 Although the Bank of Canada o f f e r s i t s lender o f l a s t r e s o r t f a c i l i t i e s to the Bank of B r i t i s h Columbia d u r i n g the normal business hours i n Vancouver, t h i s does not apply to the Bank of Canada's lender of l a s t r e s o r t f a c i l i t i e s which are a v a i l a b l e to l o c a l d e a l e r s . The E a s t e r n time continues to p r e v a i l i n cases where the l o c a l agency of the Bank of Canada i s requested by l o c a l d e a l e r s to p r o v i d e i n v e n t o r y f i -nancing under i t s purchase and r e s a l e agreements. 1 T h e r e f o r e , d e a l e r s i n Vancouver are p r e c l u d e d from u s i n g the lender of l a s t r e s o r t f a c i l i t i e s o f the Bank of Canada a f t e r the Bank's head o f f i c e i n Ottawa c l o s e s which i s two o ' c l o c k Vancouver time. T h i s aspect of l o c a l o p e r a t i o n s of the Bank r e f l e c t s the l i m i t e d autonomy given to agencies of the Bank. L o c a l d e a l e r s d e s c r i b e the l o c a l Bank of Canada agency as a l i s t e n i n g post with l i t t l e or no freedom to p a r t i c i p a t e i n the l o c a l money market without e x p l i c i t i n s t r u c t i o n s from the Bank of Canada i n Ottawa. Not a l l E a s t e r n o u t l e t s are c l o s e d t o l o c a l i n v e s t o r s at two o ' c l o c k , however. The time d i f f e r e n c e between Vancouver and Winnipeg i s o n l y two hours which means t h a t access to the i s s u e r s of g r a i n paper i s p o s s i b l e f o r an hour a f t e r the Toronto and Montreal o f f i c e s c l o s e . The i m p o s i t i o n by the Bank of E a s t e r n time c o n s t r a i n t s on l o c a l d e a l e r s ' access to the Bank's le n d e r o f l a s t r e s o r t f a -c i l i t i e s was brought out i n a d i s c u s s i o n w i t h H.A.N. Janssen, the Vancouver r e p r e s e n t a t i v e of the s e c u r i t i e s department of the Bank of Canada. T h i s was on the o c c a s i o n o f Mr. Janssen's address to students i n a f i n a n c e course, at U.B.C. on March 1, 1971. 120 An area which i s not separated from the Vancouver market by a d i f f e r e n t time zone i s the Western United S t a t e s . The p h y s i c a l p r o x i m i t y , the north-south trade f l o w s , and the common time zone a l l c o n t r i b u t e to the investment a c t i v i t y between Vancouver and such c i t i e s i n the Western United S t a t e s as S e a t t l e , Tacoma, P o r t l a n d , Los Angeles and San F r a n c i s c o . As Eaton and Bond p o i n t out, "These t r a n s a c t i o n s f i t both Canadian and U.S. west c o a s t time preference."''" In some cases, Vancouver d e a l e r s have been able to o b t a i n i n v e n t o r y f i n a n c i n g i n banks i n these American c i t i e s . The time d i f f e r e n t i a l between Vancouver and Toronto-Montreal does have i t s b e n e f i t s , however. While l o c a l i n v e s -t o r s view i t as harmful i n t h a t i t can t e m p o r a r i l y r e s t r i c t t h e i r a b i l i t y to s e l e c t from the wide range o f short-term i n -struments a v a i l a b l e to E a s t e r n i n v e s t o r s , l o c a l borrowers view i t as having b e n e f i t s . I t i s seen as making l o c a l i s s u e s more a t t r a c t i v e to l o c a l i n v e s t o r s than they would be o t h e r -wise s i n c e these s e c u r i t i e s are a v a i l a b l e a f t e r the E a s t e r n market i s c l o s e d . They are a l s o a v a i l a b l e to E a s t e r n i n v e s -t o r s whose funds become a v a i l a b l e f o r investment a f t e r E a s t e r n market a c t i v i t i e s have ceased. In summary, the time zone d i f f e r e n t i a l , l i k e the l a c k of l o c a l d e a l e r autonomy, a f f e c t s each type of p a r t i c i p a n t . Eaton and Bond, op. c i t . , p. 15. 121 I t can prevent the l o c a l i n v e s t o r from having a wide range of cho i c e among investment o p p o r t u n i t i e s and thereby may f r u s -t r a t e him i n h i s attempts to achieve an o p t i m a l p o r t f o l i o . L i k e the d e l a y s caused by the l a c k of l o c a l d e a l e r autonomy, i t may f o r c e him to simply bank h i s funds o v e r n i g h t and o b t a i n lower than a n t i c i p a t e d r e t u r n s . S e c u r i t i e s possess lower l e v e l s of l i q u i d i t y when onl y the Vancouver market i s open f o r t r a d i n g and t h i s must be c o n s i d e r e d by the l o c a l i n v e s t o r when c a l c u l a t i n g the NPV of an investment and would be r e f l e c -ted i n a lower c e r t a i n t y e q u i v a l e n t c o e f f i c i e n t . The e f f e c t of the time zone d i f f e r e n t i a l upon the l i q u i d i d t y of money market s e c u r i t i e s i s a major f a c t o r u n d e r l y i n g the low l e v e l of demand by l o c a l i n v e s t o r s f o r Government of Canada t r e a s u r y b i l l s . While the cash flows a s s o c i a t e d with t r e a s u r y b i l l s are g e n e r a l l y regarded as c e r t a i n cash flows and under the c e r t a i n t y - e q u i v a l e n t approach would normally be m u l t i p l i e d by a c e r t a i n t y - e q u i v a l e n t c o e f f i c i e n t of one i n c a l c u l a t i n g the net p r e s e n t value of the investment, t h i s i s not the case when a Vancouver i n v e s t o r e v a l u a t e s an investment i n t r e a s u r y b i l l s . In t h i s case the c o e f f i c i e n t i s s u b s t a n t i a l l y reduced to r e f l e c t the f a c t t h a t the l i q u i d i t y o f t r e a s u r y b i l l s f a l l s s h a r p l y when the Toronto-Montreal market c l o s e s . As a r e s u l t of the s m a l l e r l o c a l market f o r money market s e c u r i t i e s the m a r k e t a b i l i t y o f t r e a s u r y b i l l s d e c l i n e s . The c a p i t a l c e r -t a i n t y of t r e a s u r y b i l l s shows a s i m i l a r d e c l i n e t o r e f l e c t the p o s s i b i l i t y t h a t such instruments may prove u n s a l e a b l e during the l a s t three business hours i n Vancouver. Such a decline i n l i q u i d i t y with a corresponding reduction of the certainty-equivalent c o e f f i c i e n t results i n a low net present value for investments i n treasury b i l l s by Vancouver investors and seems to be the main factor causing the limited degree of l o c a l demand for such s e c u r i t i e s . For the l o c a l borrower, being the only available alternative to the low rates of return which can be obtained from the banks overnight, and thus a t t r a c t i v e to both l o c a l and Eastern investors, the time zone d i f f e r e n t i a l tends to hold down the short-term cost of c a p i t a l . It does so by pro-viding an attractiveness to the l o c a l issuer's s e c u r i t i e s which would otherwise have to be produced by increasing the associated i n t e r e s t payments. The time zone d i f f e r e n t i a l can create serious commu nicat i o n problems for the l o c a l dealer who wishes to consult with his superior i n the East. This problem i s accentuated by the lack of l o c a l dealer autonomy which requires that such consultation be r e l a t i v e l y frequent. The time zone di f f e r e n t t i a l l i m i t s the l i q u i d i t y of the dealer's inventory which i s detrimental to the p r o f i t a b i l i t y of his investment i n money market operations by lowering the l e v e l of expected net cash inflows. The d i f f e r e n t i a l can also be detrimental to the p r o f i t a b i l i t y of money market operations by forcing the deale to finance his inventory i n Vancouver at higher rates than 123 p r e v a i l i n the E a s t e r n time zones. A high e r c o s t o f c a p i t a l i s the r e s u l t of such a case. The time zone d i f f e r e n t i a l , then, i s an exogenous v a r i a b l e which must be seen as having an e f f e c t on the l o c a l money market p a r t i c i p a n t s . I I I . THE LEVEL OF SOPHISTICATION EXHIBITED BY VANCOUVER INVESTORS AND BORROWERS Among those p a r t i c i p a n t s i n the Vancouver money market who are f a m i l i a r w i t h the E a s t e r n market there i s ge n e r a l agreement as to the r e l a t i v e l a c k of s o p h i s t i c a t i o n which i s an a t t r i b u t e of the a c t i v i t i e s of l o c a l borrowers and i n v e s t o r s i n comparison to those i n v o l v e d i n the E a s t e r n market. S o p h i s t i c a t i o n w i t h r e g a r d t o money market a c t i v i t i e s may be d e f i n e d as the i n v e s t o r ' s a b i l i t y to achieve the o p t i -mal p o r t f o l i o of money market instruments and the borrower's a b i l i t y to o b t a i n the lowest p o s s i b l e c o s t of short - t e r m funds. For a p a r t i c i p a n t to achieve a hig h degree of so-p h i s t i c a t i o n as d e f i n e d above, he has three b a s i c requirements which must be f u l f i l l e d . These requirements are the need f o r knowledge of the s u b t l e t i e s and c o m p l e x i t i e s of the money market, the need f o r an understanding of the m o t i v a t i o n s and o b j e c t i v e s o f other market p a r t i c i p a n t s as they are embodied i n the p a r t i c i p a n t behaviour models o u t l i n e d i n Chapter I I , and the need f o r knowledge of the complete range of a v a i l a b l e 124 o p p o r t u n i t i e s a f f o r d e d by the money market. E s s e n t i a l l y , these t h r e e requirements can be summarily d e s c r i b e d as the need f o r i n f o r m a t i o n . Inasmuch as complete i n f o r m a t i o n i s assumed to be a requirement f o r a p e r f e c t market, the hig h l e v e l o f s o p h i s t i c a t i o n which r e s u l t s from having complete i n f o r m a t i o n can be regarded as important to the overcoming of money market i m p e r f e c t i o n s . The s u b o p t i m i z a t i o n of s h o r t -term investment p o r t f o l i o s and the e x i s t e n c e of u n n e c e s s a r i l y h i g h s h o r t - t e r m borrowing c o s t s are both evidence o f an im-p e r f e c t money market. Perhaps the most obvious i n d i c a t i o n of l a c k o f so-p h i s t i c a t i o n on the p a r t o f a p a r t i c i p a n t i s h i s d e s c r i p t i o n of h i s money market o p e r a t i o n s as being a very simple p r o c e s s , t h a t i s , as merely borrowing or i n v e s t i n g funds. T h i s des-c r i p t i o n o f p a r t i c i p a n t s 1 involvement i n the market was en-countered d u r i n g the course o f the i n t e r v i e w s conducted f o r t h i s study. Such a d e s c r i p t i o n was used by p a r t i c i p a n t s i n -terviewed w i t h regard to both t h e i r own o p e r a t i o n s and to the o p e r a t i o n s of o t h e r s . Examples of the complex and s u b t l e f a c e t s of the market would be the term s t r u c t u r e o f i n t e r e s t rates,"*" the 2 r e l a t i o n s h i p between nominal and e f f e c t i v e i n t e r e s t r a t e s , "'"The term s t r u c t u r e of i n t e r e s t r a t e s i s d e f i n e d as the r e l a t i o n s h i p between y i e l d and m a t u r i t y on s e c u r i t i e s d i f f e r i n g o n l y i n l e n g t h of time to m a t u r i t y . 2 The r e l a t i o n s h i p between nominal and e f f e c t i v e i n -t e r e s t r a t e s i s brought out i n the subsequent s e c t i o n d i s -c u s s i n g the d i f f e r e n c e between i n t e r e s t - b e a r i n g and d i s c o u n t instruments. the p o s s i b i l i t y o f p r o f i t a b l y " r i d i n g the y i e l d curve," a f a m i l i a r i t y w i t h the impact of f i s c a l and monetary p o l i c y on the market, and g e n e r a l l y those p o t e n t i a l b e n e f i t s and r i s k s a s s o c i a t e d w i t h p a r t i c i p a t i o n i n the market. The i m p l i c a t i o n s of a l a c k of knowledge of such market c o m p l e x i t i e s are many. Both borrowers and l e n d e r s may misjudge the t i m i n g of and/or d i r e c t i o n of changes i n i n t e r e s t r a t e s . T h i s may r e s u l t i n borrowers paying more than necessary to o b t a i n funds or not o f f e r i n g s u f f i c i e n t i n t e r e s t and thereby being t e m p o r a r i l y s h o r t o f funds. Lenders may r e q u i r e too l i t t l e f o r t h e i r funds and, as a r e s u l t , r e c e i v e a r e t u r n on t h e i r investment below t h a t g e n e r a l l y a v a i l a b l e . Or they may seek too high a r e t u r n and subsequently not be able to o b t a i n s u i t a b l e investment o p p o r t u n i t i e s . Ignorance o f the impact of economic developments on an investment may r e s u l t i n f a i l u r e to p e r c e i v e t h a t a r e l a t i v e l y r i s k l e s s instrument may become much r i s k i e r i n a An example shown i n Van Home, op. c i t . , p. 426 i s c i t e d here to i l l u s t r a t e the process of r i d i n g the y i e l d c urve. The y i e l d curve shows the r e l a t i o n s h i p between y i e l d and m a t u r i t y on s e c u r i t i e s of the same d e f a u l t r i s k . R i d i n g the y i e l d curve i n v o l v e s s e l l i n g s e c u r i t i e s b e f o r e they ma-t u r e and r e q u i r e s an upward s l o p i n g y i e l d curve. I f 180-day t r e a s u r y b i l l s y i e l d 6 per cent and 90-day t r e a s u r y b i l l s 5 per cent, and the i n v e s t o r buys the 180-day b i l l s now and s e l l s them 90 days l a t e r at a y i e l d of 5 per c e n t, h i s r e t u r n per annum f o r the h o l d i n g p e r i o d i s 7.2 per cent. T h i s example assumes t h a t the y i e l d curve does not change over the h o l d i n g p e r i o d . I g n o r i n g t r a n s a c t i o n c o s t s , the i n v e s t o r buys the 180-day b i l l s at a p r i c e o f $97, at which p r i c e they y i e l d 6 per cent to m a t u r i t y , and s e l l s them 90 days l a t e r f o r $98.75,where they y i e l d 5 per cent to m a t u r i t y . Thus,he r e a l i z e s a h o l d i n g - p e r i o d y i e l d of (1.75/97) (360/90]=7.2 per cent. 126 b r i e f p e r i o d . An economic expansion or r e c e s s i o n (even o f a r e g i o n a l nature) can a f f e c t the c r e d i t worthiness o f many i s s u e r s and thereby change the r i s k complexion of an i n v e s t -ment p o r t f o l i o . Monetary and f i s c a l p o l i c i e s can have s i m i -l a r impacts. The d i f f e r e n c e between the nominal and e f f e c t i v e r a t e s of i n t e r e s t should be c o n s i d e r e d i n the d e c i s i o n to borrow v i a the money market or v i a the c h a r t e r e d banks. An i n v e s t o r should make a s i m i l a r c o n s i d e r a t i o n when e v a l u a t i n g v a r i o u s investment o p p o r t u n i t i e s . In the course o f the i n t e r v i e w s f o r t h i s study another s i g n o f t h i s l a c k of s o p h i s t i c a t i o n was encountered as i t a p p l i e s to those l o c a l p a r t i c i p a n t s who are le n d e r s or i n v e s t o r s . I t was seen i n the l a c k o f awareness on the p a r t of p a r t i c i p a n t s o f the d i f f e r e n c e between an i n t e r e s t - b e a r i n g s e c u r i t y purchased a t par and an instrument s o l d at a d i s c o u n t and maturing at the par v a l u e . 1 The example shown i n the f o o t -note i n d i c a t e s t h a t the e f f e c t i v e i n t e r e s t r a t e i s hi g h e r than the nominal r a t e i n the case of a di s c o u n t e d s e c u r i t y so t h a t A b r i e f example i s c i t e d here to c l a r i f y the d i f f e r -ence between i n t e r e s t b e a r i n g and d i s c o u n t s e c u r i t i e s : A. 5% i n t e r e s t - B e a r i n g Note maturing i n one year. I n v e s t o r buys note a t face value of $1,000. At m a t u r i t y the i n v e s t o r i s r e p a i d h i s $1,000 i n v e s t -ment p l u s $50 i n i n t e r e s t payments (.05 x $1,000 = $50). The i n c r e a s e of the i n v e s t o r ' s wealth ($50) as a percentage o f h i s i n i t i a l investment ($1,000) i s 50 x 100 = 1000 In t h i s case the nominal i n t e r e s t r a t e and the e f f e c t i v e i n t e r e s t r a t e are i d e n t i c a l . such a s e c u r i t y w i l l always y i e l d a h i g h e r r e t u r n on i n v e s t -ment than an i n t e r e s t - b e a r i n g s e c u r i t y purchased at i t s par value i f both instruments have the same nominal i n t e r e s t r a t e . The advantage of the h i g h e r r e t u r n on investment o f f e r e d by the d i s c o u n t e d s e c u r i t y v a r i e s w i t h the absolute l e v e l of nom-i n a l i n t e r e s t r a t e s w i t h the i n c e n t i v e to i n v e s t i n d i s c o u n t e d instruments i n c r e a s i n g as the l e v e l of nominal r a t e s r i s e s . N e v e r t h e l e s s , other t h i n g s being e q u a l , the d i s c o u n t e d s e c u r i -t y always r e s u l t s i n a h i g h e r NPV/OUTLAY r a t i o t o the i n v e s t o r . I t has been i n d i c a t e d by l o c a l d e a l e r s t h a t the s i g n i -f i c a n c e of t h i s d i f f e r e n c e between i n t e r e s t - b e a r i n g and d i s -count s e c u r i t i e s i s e i t h e r ignored or de-emphasized by many l o c a l i n v e s t o r s . T h i s aspect of the l o c a l market i s e v i d e n t i n the n o t a b l y d i f f e r i n g p r o p o r t i o n s of i n t e r e s t - b e a r i n g s h o r t - t e r m s e c u r i t i e s to d i s c o u n t e d short-term s e c u r i t i e s purchased by l o c a l i n v e s t o r s i n comparison to E a s t e r n i n v e s t o r s . B. 5% Discount Note maturing a t par i n one year. I n -v e s t o r buys note a t face value l e s s face value times nominal i n t e r e s t r a t e , t h a t i s $1,000 - ($1,000 x .05) = $1,000 - $50 = $950. At m a t u r i t y the i n v e s t o r i s r e p a i d the par value of the bond, h i s i n t e r e s t income being the d i f f e r e n c e between the purchase and the redemption p r i c e ($1,000 - $950 = $50) (Note t h a t the income a c t u a l l y gained i s the same i n e i t h e r c a s e ) . However, the i n c r e a s e of the i n v e s t o r ' s wealth ($50) as a percentage of h i s i n i t i a l investment ($950) i s 50 x 100 c — 9 5 0 = 5 - 2 6 % In t h i s case the nominal i n t e r e s t r a t e and the e f f e c -t i v e i n t e r e s t r a t e d i f f e r . 128 The former p r o p o r t i o n i s much higher i n Vancouver money mar-ket t r a n s a c t i o n s than i n E a s t e r n market t r a n s a c t i o n s . In a d d i t i o n to the o b s e r v a t i o n s o f l o c a l d e a l e r s w i t h r e g a r d to t h i s phenomenon, s u b s t a n t i a t i o n was obtained from l o c a l i s s u -e r s o f short - t e r m instruments a v a i l a b l e i n e i t h e r i n t e r e s t -b e a r i n g o r di s c o u n t e d form. Since a high p r o p o r t i o n of such instruments are f u l l y r e g i s t e r e d i t i s q u i t e easy f o r an i s s u e r to monitor the geographic d i s p e r s i o n o f most of an i s s u e . These i s s u e r s have noted two aspects of the demand f o r t h e i r s e c u r i t i e s which show a r e l a t i o n s h i p to the geographic o r i g i n o f such demand. F i r s t , demand f o r l a r g e denomination s e c u r i t i e s g e n e r a l l y comes from the Ea s t w h i l e most of the Vancouver-based demand i s f o r s m a l l e r denominations. Second, and of p a r t i c u l a r i n t e r e s t i n t h i s d i s c u s s i o n , the major por-t i o n of E a s t e r n demand i s f o r d i s c o u n t notes w h i l e the l a r g e r p o r t i o n of Vancouver demand i s f o r s e c u r i t i e s of the i n t e r e s t -b e a r i n g form. The e x p l a n a t i o n f o r t h i s p e c u l i a r i t y o f the l o c a l market may be found among or may i n f a c t i n v o l v e a l l of the f o l l o w i n g reasons which were o f f e r e d by l o c a l market p a r t i c i -pants . 1. Some l o c a l i n v e s t o r s do not know t h a t t h e r e may be d i f f e r e n c e s between the nominal and e f f e c t i v e i n -t e r e s t r a t e s . 2. Some i n v e s t o r s who do know t h a t a d i f f e r e n c e may e x i s t between nominal and e f f e c t i v e r a t e s may not 1 2 9 know or may not f e e l t h a t the d i f f e r e n c e may be l a r g e enough to be of any importance to them i n making t h e i r investment d e c i s i o n s . 3. Some i n v e s t o r s may p r e f e r t o keep investments r e -s t r i c t e d t o the round l o t amounts of s e c u r i t i e s traded i n the i n t e r e s t - b e a r i n g form r a t h e r than the more complicated amounts t o be d e a l t w i t h when d i s -count s e c u r i t i e s are purchased. The r a t i o n a l e behind the t h i r d reason c i t e d above i s th a t i n many cases the manager of a f i r m ' s short-term investments may o n l y devote a few hours a week--sometimes a few minutes--to t h i s chore and may not wish t o complicate the process i n any way. A l s o , such a manager may have to r e p o r t to s u p e r i -ors who have l i t t l e or no knowledge of short-term investment p r a c t i c e s and the d e s i r e on the manager's p a r t to keep the process simple may stem from h i s apprehension o f or d i s l i k e of having to e x p l a i n any techniques he uses t o h i s less-know-ledgeable s u p e r i o r s . The importance o f an understanding o f the motiva-t i o n and o b j e c t i v e s of market p a r t i c i p a n t s should not be underestimated. Accuracy i n p r e d i c i t i o n s of market behaviour g e n e r a l l y accrues to those who possess t h i s a t t r i b u t e as un-d e r s t a n d i n g p a r t i c i p a n t behaviour permits a n t i c i p a t i o n o f market r e a c t i o n s to exogenous shocks. F u r t h e r to t h i s , view-i n g a p a r t i c i p a n t ' s a c t i o n s i n the p e r s p e c t i v e of a b e h a v i o u r a l 130 model may a l l o w another p a r t i c i p a n t (a customer or a compe-t i t o r ) t o enhance h i s b a r g a i n i n g p o s i t i o n . For example, an i s s u e r may be a b l e to c a p i t a l i z e on h i s knowledge t h a t i n -v e s t o r s are r i s k averse. To minimize h i s own c o s t o f s h o r t -term c a p i t a l he may be a b l e to induce i n v e s t o r s to accept lower i n t e r e s t payments i f he p r o v i d e s evidence of c o n t r a c -t u a l ( p a i d - f o r ) l i n e s o f c r e d i t as a d d i t i o n a l s e c u r i t y f o r h i s l i a b i l i t y as r e p r e s e n t e d i n h i s s h o r t - t e r m i s s u e . The c o s t o f such l i n e s of c r e d i t may be l e s s ' t h a n the savings from lower i n t e r e s t charges and, i f t h i s were so, would r e -s u l t i n a lower c o s t of s h o r t - t e r m c a p i t a l t o the i s s u e r . Often c i t e d as evidence of l a c k of s o p h i s t i c a t i o n i s the apparent p r e f e r e n c e shown by l o c a l i n v e s t o r s f o r the instruments of l o c a l l y - b a s e d i s s u e r s . During the course of the i n t e r v i e w s conducted f o r t h i s study, some i n v e s t o r s ad-m i t t e d t h a t i n some cases a l o c a l i s s u e i s purchased i n p r e f -erence to a n o n - l o c a l i s s u e d i f f e r i n g o n l y i n p l a c e of o r i g i n . Such i n v e s t o r ' s a c t i o n s are a r e f l e c t i o n of a form o f p r o v i n -c i a l i s m (akin to n a t i o n a l i s m ) and are excused by the i n v e s t o r s on the b a s i s o f the d e s i r e to promote l o c a l economic a c t i v i t y by augmenting l o c a l investment or simply to p r o v i d e a s s i s t a n c e to borrowers w i t h whom they are f a m i l i a r . The purchase of l o c a l i s s u e s having promised y i e l d s i d e n t i c a l to n o n - l o c a l i s s u e s but p o s s e s s i n g g r e a t e r p o t e n t i a l l e v e l s o f r i s k due to the g r e a t e r v a r i a b i l i t y of f i n a n c i a l h e a l t h on the p a r t of the l o c a l i s s u e r , may not be i n c o n s i s t e n t w i t h the model of i n v e s t o r behaviour assumed to determine i n v e s t o r s ' a c t i o n s . The g r e a t e r f a m i l i a r i t y w i t h and proxim-i t y to the i s s u e r may p r o v i d e the l o c a l i n v e s t o r w i t h b e t t e r and cheaper forma! and i n f o r m a l means of m o n i t o r i n g the i s s u -e r ' s f i n a n c i a l p o s i t i o n . These lower i n f o r m a t i o n c o s t s augu-ment the net cash i n f l o w s viewed w i t h c e r t a i n t y by the i n v e s -t o r and the s u p e r i o r m o n i t o r i n g w i l l a llow the i n v e s t o r to q u i c k l y p e r c e i v e changes i n r i s k l e v e l s and a c c o r d i n g l y ad-j u s t h i s p o r t f o l i o . Since t h i s behaviour by l o c a l i n v e s t o r s i s due to t h e i r having more complete i n f o r m a t i o n upon which to base t h e i r investment d e c i s i o n s , r a t h e r than s e r v i n g as evidence of the l a c k of s o p h i s t i c a t i o n , such p r e f e r e n c e s f o r l o c a l i s s u e s may i n f a c t i n d i c a t e a h i g h degree o f i n v e s t o r s o p h i s t i c a t i o n . The r e l a t i v e l y low l e v e l of s o p h i s t i c a t i o n e x h i b i -ted by l o c a l i n v e s t o r s and borrowers i n t h e i r money market a c t i v i t i e s i s f r e q u e n t l y regarded as stemming from the r e l a -t i v e l y r e c e n t appearance of the market i n Vancouver. However i t would seem t h a t the cause of t h i s phenomenon a c t u a l l y l i e s i n the l a c k of i n f o r m a t i o n as d e s c r i b e d above to be the b a s i c requirements f o r the development of h i g h l e v e l s of s o p h i s t i c a t i o n . The money market p a r t i c i p a n t w i t h the g r e a t e s t amount of i n f o r m a t i o n r e q u i r e d by the other p a r t i c i p a n t s i s the i n -vestment d e a l e r . Access to t h i s i n f o r m a t i o n should l e a d to the development of a high degree of s o p h i s t i c a t i o n s i n c e i t i s i n the b e s t i n t e r e s t s of both i n v e s t o r s and borrowers to overcome the s u b o p t i m i z a t i o n of t h e i r r e s p e c t i v e g o a l achieve 132 ment. Lack of s o p h i s t i c a t i o n on the p a r t of l o c a l i n v e s t o r s and borrowers would seem to i n d i c a t e t h a t the p r o l i f e r a t i o n of i n f o r m a t i o n by investment d e a l e r s has been l e s s than s a t -i s f a c t o r y . Since money market a c t i v i t y i n the Vancouver area has o n l y r e c e n t l y become s i g n i f i c a n t , many o f those i n v e s t o r s and borrowers' p r e s e n t l y p a r t i c i p a t i n g are r e l a t i v e new-comers to the market. Many w i l l have been i n t r o d u c e d to the market by investment d e a l e r s and i n t h e i r attempt to broaden market p a r t i c i p a t i o n , the d e a l e r s may have de-emphasized the complex-i t y of the money market i n the b e l i e f t h a t p o t e n t i a l p a r t i c i -pants might be d e t e r r e d from p a r t i c i p a t i o n by the complexity ocE the market. Broader market p a r t i c i p a t i o n would be sought by a d e a l e r s i n c e the hi g h e r l e v e l o f expected cash i n f l o w s would enhance the p r o f i t a b i l i t y o f h i s investment. The i n t r o d u c t i o n of p o t e n t i a l p a r t i c i p a n t s t o the money market by investment d e a l e r s has taken much the same form as i t d i d i n the E a s t some f i v e or more years e a r l i e r : i t was a p p a r e n t l y deemed s u f f i c i e n t to i n d i c a t e to borrowers and len d e r s the f i n a n c i n g and investment or cash management b e n e f i t s to be gained from market p a r t i c i p a t i o n and to f a m i l -i a r i z e them w i t h the j a r g o n , mechanics, and main r u l e s of the road of the market. 1 There seems to be l i t t l e i f any d i f f e r e n c e i n the c u r r e n t method of e d u c a t i n g p a r t i c i p a n t s l o c a l l y compared to t h a t used i n the development stages of the E a s t e r n market. T h i s c o n c l u s i o n i s based upon a comparison of the p r e s e n t l y emphasized b e n e f i t s of market p a r t i c i p a t i o n and those o u t l i n e d i n a speech e n t i t l e d The Corporate T r e a s u r e r ' s Use of the Money Market d e l i v e r e d to the Quebec I n s t i t u t e o f C h a r t e r e d Accountants at the Board of Trade B u i l d i n g i n Montreal on May 14th, 1964 by Mr. J.C. Murphy of Burns Bros.and Denton L i m i t e d , Investment D e a l e r s . 133 Most d e a l e r s have b o o k l e t s or manuals d e s c r i b i n g the money market terminology, the instruments i n v o l v e d , and even the requirements f o r p a r t i c i p a t i o n as a borrower i n some c a s e s . 1 The u s u a l p r a c t i c e i s f o r the p a r t i c i p a n t ' s key money market personnel to spend a few days a t the money market desk of the d e a l e r who i s i n t r o d u c i n g him to the money market. T h i s q u i c k l y f a m i l i a r i z e s the p a r t i c i p a n t w i t h j a r -gon or terminology and mechanics and i s undoubtedly expected by the d e a l e r t o c o n t r i b u t e to the es t a b l i s h m e n t o f a p e r s o n a l r e l a t i o n s h i p between the d e a l e r ' s and the p a r t i c i p a n t ' s money market p e r s o n n e l and h o p e f u l l y may c r e a t e and pr o l o n g a b u s i -ness r e l a t i o n s h i p . There i s evidence, however, t h a t the i n t r o d u c t o r y i n f o r m a t i o n p r o v i d e d by the l o c a l d e a l e r s i s l e s s than com-p l e t e . As was noted e a r l i e r , a normal requirement f o r the issuance o f commercial or f i n a n c i a l paper i s the o f f e r i n g memorandum wit h i t s documentation (of the type shown i n Appendix A ) . T h i s memorandum i s viewed by most i n v e s t o r s as necessary and permits the i s s u e r to come to the market wi t h at l e a s t the appearance of p o s s e s s i n g some degree of s o p h i s -t i c a t i o n . Yet a l o c a l i s s u e r (who must remain unnamed) had not been informed by l o c a l d e a l e r s o f t h i s b a s i c requirement but, to h i s embarrassment, l e a r n e d of i t from other sources. "*"A copy of i s s u i n g Commercial and F i n a n c i a l Short  Term Promissory Notes which i s produced and d i s t r i b u t e d by A.E. Ames & Co. L i m i t e d comprises Appendix B and i s an ex-ample of e d u c a t i o n a l m a t e r i a l c u r r e n t l y being used i n the Vancouver area. While the i n f o r m a t i o n c o n t a i n e d i n d e a l e r s 1 p u b l i -c a t i o n s such as t h a t reproduced i n Appendix B may enable a p o t e n t i a l p a r t i c i p a n t to become i n v o l v e d i n money market ac-t i v i t i e s , i t i s o b v i o u s l y much below the amount of informa-t i o n which would be r e q u i r e d to promote any s i g n i f i c a n t de-gree of s o p h i s t i c a t i o n . I t i s u n l i k e l y t h a t the s o p h i s t i c a -t i o n of the l o c a l market w i l l be i n c r e a s e d by any i n f l u x o f s o p h i s t i c a t e d borrowers s i n c e there i s l i k e l y to be l e s s l o c a l a c t i v i t y by d e a l e r s i n the f u t u r e i n the area of i n t r o d u c i n g p o t e n t i a l borrowers to money market o p e r a t i o n s . T h i s r e f l e c t s the g e n e r a l consensus of l o c a l d e a l e r s t h a t there are no l o c a l f i r m s which are not u t i l i z i n g the money market f o r t h e i r s h o r t term f i n a n c i n g needs which possess the l e v e l of c r e d i t w o r t h i -ness which would allow them to do so. There i s every reason to expect t h a t the i n t r o d u c t i o n by d e a l e r s of l o c a l l e n d e r s or i n v e s t o r s to money market o p e r a t i o n s w i l l c o n t i n u e , however For those p a r t i c i p a n t s who are c u r r e n t l y i n v o l v e d i n money market o p e r a t i o n s the d e a l e r remains the most impor-t a n t source of i n f o r m a t i o n . However, the type of informa-t i o n which promotes s o p h i s t i c a t i o n seems not to be f o r t h -coming. Judging from the eagerness to improve t h e i r knowledge of the l o c a l market as expressed by p a r t i c i p a n t s d u r i n g the course of the i n t e r v i e w s conducted f o r t h i s study, the i n f o r -mation which the d e a l e r c o u l d make a v a i l a b l e would q u i c k l y r e -s u l t i n a more s o p h i s t i c a t e d market. These p a r t i c i p a n t s expre 135 d i s s a t i s f a c t i o n w i t h the l a c k o f u s e f u l i n f o r m a t i o n a v a i l -a b l e from l o c a l d e a l e r s . They p o i n t out t h a t the d e a l e r s ' market l e t t e r s are u s e f u l i n p r o v i d i n g an i n d i c a t i o n of the i s s u e s a d e a l e r handles most f r e q u e n t l y but t h a t the r a t e s quoted are nothin g more than an i n d i c a t i o n o f what c u r r e n t r a t e s may be. Such market l e t t e r s , o f course, are i s s u e d by the investment d e a l e r ' s head o f f i c e and t h e r e f o r e are not designed s p e c i f i c a l l y to serve the Vancouver market p a r t i c i p a n t s . Copies o f r e c e n t i s s u e s of the market news-l e t t e r s produced and d i s t r i b u t e d by A.E. Ames & Co. L i m i t e d and Wood Gundy S e c u r i t i e s L i m i t e d may be found i n Appendix C. In the p r o v i s i o n o f the d e a l e r ' s s e r v i c e of h e l p -i n g the i n v e s t o r put h i s funds to the best p o s s i b l e use w i t h i n the c o n s t r a i n t s of ac c e p t a b l e l e v e l s o f r i s k and l i q u i d i t y r e -quirements and i n the proper f u l f i l l m e n t of h i s r o l e as i n t e r -mediator between borrowers and l e n d e r s , the d e a l e r should p o i n t out to the i n v e s t o r any s u b - o p t i m i z a t i o n which i s i n evidence i n the p a r t i c i p a n t ' s a c t i v i t i e s . I f the i n v e s t o r i s not aware of the d i f f e r e n c e i n e f f e c t i v e y i e l d s between d i s -count and i n t e r e s t - b e a r i n g s e c u r i t i e s , t h i s d i f f e r e n c e should be p o i n t e d out by the d e a l e r . I f the i n v e s t o r f e e l s the d i f f e r e n c e i s not important enough to him to warrant the con-s i d e r a t i o n of t h i s f a c t o r i n h i s investment decision-making, the d e a l e r should i n d i c a t e e x p l i c i t l y what impact t h i s d i f f e r -ence can have on the i n v e s t o r ' s t o t a l p o r t f o l i o . Such a d o l l a r s and cents i l l u s t r a t i o n would at l e a s t ensure the 136 i n v e s t o r ' s understanding o f what the i m p l i c a t i o n s are of h i s pre s e n t investment s t r a t e g y . T h i s same approach would be u s e f u l f o r the investment manager who must r e p o r t to s u p e r i o r s w i t h l i t t l e or no knowledge of money market a c t i v i t i e s . Such a manager would then know the c o s t s o f h i s u n w i l l i n g n e s s to d e a l i n the s l i g h t l y more complex d i s c o u n t s e c u r i t i e s market or he c o u l d use the d e a l e r ' s p r e s e n t a t i o n to e x p l a i n the t e c h -nique to h i s s u p e r i o r s . I t would seem t h a t r a t h e r than merely w a i t i n g f o r the Vancouver money market to mature and perhaps become more s o p h i s t i c a t e d , the r a t h e r simple steps o u t l i n e d aboue would help move the market toward a higher l e v e l of s o p h i s t i c a t i o n . There may be some h e s i t a t i o n on the p a r t o f d e a l e r s to hasten the growth of s o p h i s t i c a t i o n i n the l o c a l market s i n c e more s o p h i s t i c a t e d i n v e s t o r s c o u l d be expected to demand more com-p l e t e and more e f f i c i e n t s e r v i c e from the d e a l e r s . Such a p o s s i b i l i t y may be p r e s e n t l y p e r c e i v e d by the d e a l e r s as being u n d e s i r a b l e s i n c e the r e l a t i v e l y s m a l l market which c u r r e n t l y e x i s t s may not be regarded as warrant i n g the a d d i t i o n a l i n v e s t -ment i n money market o p e r a t i o n s which would be r e q u i r e d to meet demands f o r complete i n f o r m a t i o n s e r v i c e s . T h i s concludes Chapter V and s i n c e t h i s study has now (1) o u t l i n e d the o v e r a l l s e t t i n g i n which the Vancouver money market e x i s t s , (2) d e s c r i b e d the Vancouver money market i t s e l f , (3) i n d i c a t e d the major p e c u l i a r i t i e s and i m p e r f e c t i o n s o f t h a t market, and (4) presented e x p l a n a t i o n s f o r such p e c u l i a r i t i e s and i m p e r f e c t i o n s where possible", the s t a t e d o b j e c t i v e s o f t h i s study have been a t t a i n e d and t h i s t h e r e f o r e concludes the body of t h i s study. 137 CHAPTER VI CONCLUSION Th i s chapter concludes the study by p r e s e n t i n g a b r i e f synopsis of the m a t e r i a l i n c l u d e d i n each chapter of the main body of the study, i n d i c a t i n g the main c o n t r i b u t i o n of each chapter, and p o i n t i n g out those areas which deserve f u t u r e i n v e s t i g a t i o n . In the course of examining the Vancouver money market t h i s study has addressed i t s e l f to the fou r o b j e c t i v e s as o u t l i n e d i n Chapter I. Those o b j e c t i v e s are as f o l l o w s : 1. To p r o v i d e a d e s c r i p t i o n of the o v e r a l l s e t t i n g i n which the Vancouver money market e x i s t s . 2. To d e s c r i b e the Vancouver money market. 3. To i n d i c a t e the major p e c u l i a r i t i e s and imper-f e c t i o n s which e x i s t i n t h a t market. 4. To p r o v i d e , where p o s s i b l e , e x p l a n a t i o n s f o r those p e c u l i a r i t i e s and i m p e r f e c t i o n s . Chapter I I , The Canadian Money Market: Concepts And Func t i o n s and Chapter I I I , Canadian Money Market Instruments d e s c r i b e and examine the o v e r a l l s e t t i n g i n which the Vancouver money market e x i s t s to achieve the f i r s t o b j e c t i v e of the study. P a r t I of Chapter I I p r o v i d e s a c o n c e p t u a l i z a t i o n . of the money market which p o i n t s out the i n t e r r e l a t i o n s h i p between i n v e s t o r s , borrowers, and i n t e r m e d i a r i e s and i n d i -c a tes how economic a c t i v i t y i s f a c i l i t a t e d by the equating of supply o f and demand f o r short-term c a p i t a l v i a the money market. The main c o n t r i b u t i o n of Chapter I I l i e s i n the p r e s e n t a t i o n of the models of p a r t i c i p a n t behaviour. Draw-i n g on the concepts embodied i n p r o f i t a b i l i t y c r i t e r i a f o r investment d e c i s i o n s , b e h a v i o u r a l models are developed f o r the money market i n v e s t o r , the money market borrower, and the i n t e r m e d i a t o r , the investment d e a l e r . The b e h a v i o u r a l model of the money market i n v e s t o r d e s c r i b e s t h a t p a r t i c i p a n t as seeking the maximum net pr e s e n t value per u n i t of o u t l a y of the cash flows a s s o c i a t e d with an investment which are regarded as being c e r t a i n as c a l c u l a t e d under the c e r t a i n t y -e q u i v a l e n t approach. The b a s i c g o a l u n d e r l y i n g the borrower 1 money market a c t i v i t i e s i s the m i n i m i z a t i o n of the borrower's c o s t of short - t e r m c a p i t a l where the c o s t of short- t e r m c a p i -t a l i s viewed as t h a t d i s c o u n t r a t e which equates the net pre s e n t v a l u e of payments t o the s u p p l i e r s of such funds to the proceeds r e c e i v e d by the borrower. Investment d e a l e r be-haviour i s determined by t h a t p a r t i c i p a n t ' s g o a l of maximiza-t i o n of the net p r e s e n t v a l u e of the expected cash flows asso c i a t e d w i t h h i s money market o p e r a t i o n s as di s c o u n t e d by the 139 f i r m ' s a p p r o p r i a t e l y weighted c o s t of c a p i t a l . F i n a l l y , t h i s s e c t i o n u n d e r l i n e s the importance of an awareness of the i n -terdependence of the three p a r t i c i p a n t s . S e c t i o n I I I of Chapter I I serves to d e s c r i b e the na-tur e of money market instruments by comparing t a n g i b l e a s s e t s and f i n a n c i a l a s s e t s . Since l i q u i d i t y i s an important aspect of the money market's f u n c t i o n s , the e l a b o r a t i o n on the con-cept of l i q u i d i t y and e s p e c i a l l y on the r e l a t i o n s h i p o f the m a r k e t a b i l i t y and c a p i t a l c e r t a i n t y of a s s e t s serves as a major c o n t r i b u t i o n of the chapter. S e c t i o n IV b r i e f l y out-l i n e s the development of the Canadian money market from 1934 when i t may be s a i d to have begun and a l s o d i s c u s s e s the im-plementation of the monetary p o l i c i e s o f the Bank of Canada v i a the money market. The chapter concludes with a s e c t i o n which p r o v i d e s an example of the f u n c t i o n s o f the money mar-ket which i n d i c a t e d t h a t the market f a c i l i t a t e s the equating of supply and demand of short-term c a p i t a l a t lower c o s t s to p a r t i c i p a n t s than would be the case without such a market. A l s o shown i s the importance of the investment d e a l e r i n pre -v e n t i n g s h i f t s o f d e p o s i t s between banks from s e r i o u s l y d i s -r u p t i n g the t o t a l banking community. To complete the d e s c r i p t i o n of the s e t t i n g i n which the Vancouver money market e x i s t s , Chapter I I I i n d i c a t e s the major a t t r i b u t e s of the f o u r t e e n instruments which make up the stock i n trade of the Canadian money market. These i n s t r u -140 merits i n c l u d e the l i a b i l i t i e s of governments ( f e d e r a l , p r o -v i n c i a l , and municipal) and t h e i r agents, banks, t r u s t com-p a n i e s , mortgage and loan companies, acceptance and f i n a n c e companies, n o n - f i n a n c i a l companies, and investment d e a l e r s . F i n a l l y , these instruments are r e s p e c t i v e l y ranked a c c o r d i n g to t h e i r t h r e e main c h a r a c t e r i s t i c s of r i s k , l i q u i d i t y , and y i e l d to m a t u r i t y . The main c o n t r i b u t i o n o f the chapter l i e s i n i t s s e r v i n g to i n d i c a t e the d i v e r s i t y which e x i s t s i n the a s s e t s t r a d e d i n the money market and a l s o among the p a r t i c i p a n t s i n t h a t market. I t i s the purpose of Chapter IV, The Recently E v o l -ved Vancouver Money Market And I t s Low L e v e l o f Dealer Inven-t o r i e s and Chapter V, A d d i t i o n a l P e c u l i a r i t i e s Of The Vancouver Money Market, to s a t i s f y the th r e e remaining o b j e c t i v e s of the study. S e c t i o n I of Chapter IV d i s c u s s e s the r e c e n t growth of the Vancouver money market s i n c e 1966. While twelve of the f i f t e e n money market jobbers now have o f f i c e s i n Vancouver, the bulk of the market a c t i v i t y i n v o l v e s o n l y f i v e o f these d e a l e r s . P a r t i c i p a t i o n by both borrowers and i n v e s t o r s has i n -creased over the past f i v e years but although the l o c a l market has grown s u b s t a n t i a l l y , i t s t i l l i s dwarfed by the Toronto-Montreal market. S e c t i o n I I of Chapter IV d i s c u s s e s the low l e v e l o f d e a l e r i n v e n t o r i e s o f money market instruments i n Vancouver. I t i s i n d i c a t e d t h a t w h i l e the s m a l l e r Vancouver market may not o f f e r the o p p o r t u n i t i e s f o r p r o f i t or the l i q u i d i t y f o r 141 s a f e t y , the d i f f i c u l t i e s of f i n a n c i n g l o c a l i n v e n t o r y and the e x i s t e n c e of other a l t e r n a t i v e s to l o c a l i n v e n t o r i e s seem to be the s t r o n g e r f a c t o r s u n d e r l y i n g the low l e v e l s of d e a l e r i n v e n t o r y . The main c o n t r i b u t i o n of t h i s chapter i s to be found i n the d i s c u s s i o n of the problems f a c i n g d e a l e r s i n f i -nancing an i n v e n t o r y of money market instruments which i n d i -c a tes t h a t the s o l u t i o n to t h i s problem i s s u b s t a n t i a l l y be-yond the c o n t r o l of the investment d e a l e r s . The d e a l e r s can o n l y look to the Western United S t a t e s f o r r e l i e f to t h i s problem which stems from the f i n i t e number of l o c a l sources of i n v e n t o r y l o a n s . The d e c e n t r a l i z a t i o n of the cash manage-ment process of the c h a r t e r e d banks with the c o n c u r r e n t de-c e n t r a l i z a t i o n of the management of day loans and c a l l loans to investment d e a l e r s would p r o v i d e a s o l u t i o n to t h i s prob-lem. The impact on the l o c a l market, i t s p a r t i c i p a n t s , the r e g i o n a l and n a t i o n a l economy, and the c h a r t e r e d banks which would r e s u l t from the aforementioned d e c e n t r a l i z a t i o n i s an area which warrants f u t u r e i n v e s t i g a t i o n . A f t e r d i s c u s s i n g such d e v i c e s p r o v i d i n g a l t e r n a t i v e s to d e a l e r i n v e n t o r y as l e t t e r s of u n d e r t a k i n g , the i s s u e of notes by agents, the Bank of Canada t r a n s f e r s e r v i c e , and l o c a l l y - i s s u e d instruments, the chapter concludes by p o i n t i n g out t h a t low d e a l e r i n v e n -t o r i e s r e s t r i c t the l o c a l i n v e s t o r i n h i s attempt to achieve an optimal p o r t f o l i o of short-term investments while Vancouver borrowers b e n e f i t from the s i t u a t i o n by being able to c a p i t a l -i z e upon the i n v e s t o r s ' u n f i l l e d needs. 142 Chapter V completes the study by d i s c u s s i n g some a d d i t i o n a l p e c u l i a r i t i e s of the Vancouver money market. P a r t I i n d i c a t e s t h a t the d e a l e r s ' l a c k of l o c a l autonomy due t o the c e n t r a l i z a t i o n o f d e c i s i o n making and l i m i t e d l o c a l i n v e n t o r i e s produces delays i n market t r a n s a c t i o n s which i n h i b i t the achievement of investment goals by the i n v e s t o r , decrease the l i q u i d i t y o f h i s investments, and r a i s e the borrower's c o s t of short- t e r m c a p i t a l . S e c t i o n I I c o n s i d e r s the i m p l i c a t i o n of the time zone d i f f e r e n t i a l between the Vancouver and E a s t e r n markets. T h i s d i f f e r e n t i a l can l e a d to de l a y s which r e s t r i c t the range of c h o i c e f o r Vancouver i n v e s t o r s and due to the l i m i t e d l o c a l market can s e r i o u s l y reduce the l i q u i d i t y of money market i n -vestments. L o c a l borrowers, however, can b e n e f i t from t h i s s i t u a t i o n s i n c e t h e i r s e c u r i t i e s are a v a i l a b l e a f t e r the Eas-t e r n market c l o s e s . Dealers encounter problems f i n a n c i n g i n -ventory because of the d i f f e r e n t i a l s i n c e a l l E a s t e r n - c o n t r o l l e d funds become u n a v a i l a b l e a t two o' c l o c k i n Vancouver. The f a c t t h a t , l i k e the c h a r t e r e d banks, the l o c a l Bank of Canada agency enjoys l i t t l e autonomy as evidenced i n the agency's i n a b i l i t y to o f f e r i t s l e n d e r of l a s t r e s o r t f a c i l i t i e s to l o c a l d e a l e r s a f t e r two o'c l o c k when the main Bank of Canada o f f i c e i n Ottawa c l o s e s suggests another area f o r f u t u r e study. The im-pact of some d e c e n t r a l i z a t i o n of d e c i s i o n making by the Bank of Canada upon the Vancouver money market i s suggested as a t o p i c worthy of i n v e s t i g a t i o n . T h i s t o p i c should be c o n s i d e r e d 143 as e s p e c i a l l y important s i n c e the implementation of monetary p o l i c i e s u t i l i z e s the money market and the p r o x i m i t y and s i m i -l a r t i m e - p references of the Western United S t a t e s may l e a d to a Vancouver money market which i s more re s p o n s i v e t o f o r e i g n than domestic monetary p o l i c y . In c o n c l u d i n g Chapter V, P a r t I I I examines the l e v e l of s o p h i s t i c a t i o n e x h i b i t e d by Vancouver i n v e s t o r s and borrow-e r s . These p a r t i c i p a n t s possess incomplete knowledge of the s u b t l e and complex f a c e t s of money market o p e r a t i o n s , the mo-t i v a t i o n s and o b j e c t i v e s of other market p a r t i c i p a n t s , and the range of a v a i l a b l e o p p o r t u n i t i e s a f f o r d e d by the money mar-ke t . An example r e v e a l i n g u n s o p h i s t i c a t i o n c i t e s the l a c k of awareness of the d i f f e r e n c e between i n t e r e s t - b e a r i n g s e c u r i t i e s purchased at par and instruments s o l d at a d i s c o u n t and matur-i n g at par. The apparent p r e f e r e n c e by l o c a l i n v e s t o r s f o r l o c a l i s s u e s which i s o f t e n c i t e d as evidence of l a c k of so-p h i s t i c a t i o n may i n f a c t be evidence of a high degree of so-p h i s t i c a t i o n . The major c o n t r i b u t i o n of t h i s chapter i s the c o n c l u s i o n t h a t s i n c e overcoming the l a c k of s o p h i s t i c a t i o n i n the l o c a l market can be achieved w i t h the d i s s e m i n a t i o n o f more complete i n f o r m a t i o n and s i n c e the investment d e a l e r e i t h e r possesses or has ready access to such i n f o r m a t i o n , the d e a l e r must be h e l d r e s p o n s i b l e f o r the r e l a t i v e l y u n s o p h i s t i -cated nature of the Vancouver money market. T h i s completes Chapter VI and t h e r e f o r e completes the study comprised of an examination of the Vancouver money market. 144 BIBLIOGRAPHY A. BOOKS F u l l e r t o n , Douglas H. The Bond Market i n Canada. Toronto: The C a r s w e l l Company L i m i t e d , 1962. Johnson, Harry G. Essays i n Monetary Economics. London: George A l l e n & Unwin L t d . , 1967. Keynes, John Maynard. The General Theory o f Employment, I n t e r e s t , and Money. 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New York: H o l t , R i n e h a r t and Winston, Inc., F i f t h E d i t i o n , 1968. Van Home, James C. F i n a n c i a l Management and P o l i c y . Second E d i t i o n , Englewood C l i f f s , New J e r s e y : P r e n t i c e - H a l l Inc., 1971. . F u n c t i o n and A n a l y s i s o f C a p i t a l Market Rates. Englewood C l i f f s , New J e r s e y : P r e n t i c e - H a l l Inc., 1970. 145 W i l s o n , J.S.G. Monetary P o l i c y and the Development of Money  Markets. London: George A l l e n & Unwin L t d . , 1966. Woodworth, G. Walter. The Money Market and Monetary Management. New York: Harper & Row, P u b l i s h e r s , 1965. B. PERIODICALS Eaton, G. Howard and Bond, David E. "Canada's Newest Money Market: Vancouver," The Canadian Banker, LXXVII (Winter, 1970), pp. 14-15. H i l l i e r , F r e d e r i c k S. "The D e r i v a t i o n of P r o b a b i l i s t i c I n f o r m a t i o n f o r the E v a l u a t i o n of Risky Investments," Management S c i e n c e , IX ( A p r i l , 1963), pp. 443-457. C. GOVERNMENT PUBLICATIONS Bank o f Canada, S t a t i s t i c a l Summary, November, 1970. , S t a t i s t i c a l Summary, A p r i l , 1971. D. OTHER SOURCES Ames, A.E. & Co. L i m i t e d , I s s u i n g Commercial and F i n a n c i a l  Short Term Promissory Notes. A b o o k l e t used to i n t r o -duce p o t e n t i a l i s s u e r s o f s h o r t term promissory notes to the money market from an i s s u e r ' s p o i n t . o f view,1971. , "The Money Market," March 12, 1971 (weekly). B r i t i s h Columbia Telephone Company, " O f f e r i n g Memorandum: Short Term Promissory Notes," June 30, 1970. Burns Bros, and Denton L i m i t e d , The Canadian Short Term Money  Market: Instruments and Formulae, 1965. Dominion S e c u r i t i e s C o r p o r a t i o n L i m i t e d , Canada's Short-Term  Money Market, 1966. Investment D e a l e r s ' A s s o c i a t i o n of Canada, Submission to the  Royal Commission on Banking and Finance, 1962. Murphy, J.C. "The Corporate T r e a s u r e r ' s Use o f the Money Market," An address to the Quebec I n s t i t u t e of C h a r t e r e d Accountants, M o n t r e a l , May 14, 1964. Wood Gundy S e c u r i t i e s L i m i t e d , The Canadian Money Market, 196 , "The Money Market," March 4, 1971 (weekly). P e r s o n a l i n t e r v i e w s w i t h personnel i n v o l v e d i n money market o p e r a t i o n s from the f o l l o w i n g f i f t e e n Vancouver money market p a r t i c i p a n t s : Ames, A.E. & Co. L i m i t e d Bank of B r i t i s h Columbia Bank of Canada Bank of Nova S c o t i a B r i t i s h Columbia C e n t r a l C r e d i t Union B r i t i s h Columbia Packers L i m i t e d B r i t i s h Columbia Telephone Company Burns Bros, and Denton L i m i t e d Cominco L i m i t e d K e l l y Douglas & Company L i m i t e d MacMillan B l o e d e l L i m i t e d McLeod, Young, Weir & Co. L i m i t e d Wood Gundy S e c u r i t i e s L i m i t e d Woodward Stores L i m i t e d Y o r k s h i r e T r u s t Company. 147 APPENDIX A This Appendix c o n s i s t s of a copy of the c u r r e n t o f f e r i n g memorandum ( e x c l u d i n g the annual f i n a n c i a l s t a t e -ments) of B r i t i s h Columbia Telephone Company. This offering memorandum is not and under no circumstances is to be construed as an offering of these Short Term Promissory Notes for sale in the United States of America or the territories or possessions thereof. 148 Short Term Promissory Notes BRITISH COLUMBIA TELEPHONE COMPANY Vancouver 2, British Columbia 149 SHORT TERM PROMISSORY NOTES PRINCIPAL AMOUNT: The aggregate principal amount borrowed and repayable shall not at any time exceed Fifty-five Million Dollars ($55,000,000) in Canadian funds or the equivalent thereof in any other currency. DENOMINATIONS: Short term promissory notes will be issued in the name of the purchaser thereof or in bearer form as Interest Bearing Notes, or notes issued at a discount to mature at par, in Canadian or United States currency subject to a minimum of $50,000. T E R M : RATES: DELIVERY: Up to 365 days. Available upon request. Notes can be arranged for same day delivery in Montreal, Toronto or Vancouver. ; PAYMENT: At maturity payment will be made at a chartered bank as designated on the face of the note. BANK LINES OF CREDIT: The Company has bank lines of credit with Chartered Banks totalling Thirty-eight Million, Five Hundred Thousand Dollars ($38,500,000). ELIGIBILITY: As outlined and qualified in the opinion of counsel, which forms part of this offering memorandum, the promissory notes of British Columbia Telephone Company are eligible investments under: (a) Canadian and British Insurance Companies Act (b) The Loan and Trust Corporations Act of Ontario (c) Trust Companies Act of Canada, for unguaranteed trust money. We, as agents, offer these short term notes subject to confirmation by the Company and subject to the favor-able legal opinion of Messrs. Blake, Cassels & Graydon, Toronto, Ontario. HARRIS & PARTNERS LIMITED ODLUM BROWN & T. B. READ L T D . June 30, 1970 THE COMPANY The British Columbia Telephone Company was incorporated by Special Act of the Parliament of Canada, April 12, 1916. The Company or its predecessors have carried on telephone operations in British Columbia continuously since 1880 when one of the predecessor companies on Vancouver Island com-menced the first telephone system in British Columbia. The Company, together with its subsidiary Okanagan Telephone Company acquired in 1966, furnishes a complete communications service to over 99% of the population of the Province of British Columbia. The Company is the second largest telephone company in Canada, and at June 30, 1970 had 1,003,925 tele-phones in service, over 99% of which are dial operated. In 1931, the major telephone systems in Canada formed the Trans-Canada Telephone System to provide a Canadian route for long distance services. The Company owns and operates the sections of the system in British Columbia, including the British Columbia portion of a coast-to-coast microwave radio relay network completed in 1958 and expanded several times since. In addition to regular telephone and special service transmission, this system carries the signals of two national television networks. A second microwave radio relay network, following an alternate route across British Columbia, was placed in service during May, 1970. Through this system and other connections, service is available to nearly all parts of the world. The Company also provides the operating center for the Canadian end of the Commonwealth Pacific Cable between Vancouver and Australia. Because of the rugged coastline and terrain of the province, the Company was a pioneer in the field of radiotelephony and now operates one of the world's largest radio-telephone systems, providing the links between the regular telephone system and the more than 10,000 radiotelephone sets in automobiles, aircraft, industrial vehicles, land stations serving remote settlements and ships plying coastal and international waters. The ship stations alone number over 5,000. The Province of British Columbia is the third largest in Canada in terms of population as well as man-ufacturing. According to figures issued by the Dominion Bureau of Statistics, British Columbia has, for some years, been one of Canada's fastest growing provinces. The estimated population of 2,128,000 at April, 1970 represents an increase of about 33% since April, 1960, as compared with an increase of 20% for Canada as a whole during the same period. Vancouver is the largest city in the province and the third largest in Canada with a population in its metropolitan area of 980,000 in June, 1969. It is the principal financial, shipping and manufacturing center west of Toronto and is one of the most important seaports on the Pacific coast of North America. At the present time Anglo-Canadian Telephone Company of Montreal owns 50.31% of the 2,877,000 Ordinary shares outstanding. The balance of the Ordinary shares as well as the Preference and Preferred shares are widely held throughout Canada. Anglo-Canadian is 82% controlled by General Telephone & Electronics Corporation of New York. This association gives the Company direct access to research, development and other support that would not otherwise be available through its own resources. June 30, 1970 153 154 156 F A R R I S , F A R R I S , V A U O I I A N , W I L L S 8C M U R P H Y B A R R I S T E R S Si S O L I C I T O R S H O N . J . W . D E B . F A R R I S . Q . C . C . H . W I L L S A . D . P O O L B R I A N S . L O W E M I C H A E L B U T L E R H . P. M C L A U G H L I N D A V I O B . F I N L A Y R O D N E Y K . W A R D R E P L Y A T T E N T I O N O F J O H N L . F A R R I S , O C C . F R A N C I S M U R P H Y G . S . H U G H - J O N E S P. W . B U T L E R K. A . L - H i L L M A N J . D . N . E D G A R R O G E R J . D U N C A N R . J O H N R O G E R S D . L . V A U G H A N , Q . C . B R I C E S . E V A N S J O H N D . M C A L P I N E J A C K M . G I L E S J A M E S F. R I C H A R D S O N G L E N P . B A N C R O F T T E R E N C E W . B O Y L A N I R W I N G . N A T H A N S O N Mr. D. L. Vaughan, Q.C. T E L E P H O N E 6 8 1 - 7 1 1 1 A R E A C O D E 6 0 4 C A B L E A D O R E S S " F A R E M " I S ™ F L O O R S I O W E S T H A S T I N G S S T R E E T V A N C O U V E R 2 , B . C . June 3 0 , 1 9 6 9 . B r i t i s h Columbia Telephone Company, Odium Brown & T. B. Read Ltd., Harris & Partners Limited, Dear Sirs: We have acted as counsel for B r i t i s h Columbia Telephone Company (the "Company") in connection with the roposed sale of i t s unsecured short term promissory notes the "Notes") in maturities up to 3 6 5 days from the respec-tive dates of issue. We have examined the special Act of Parliament of Canada incorporating the Company and a l l amendments there-to, the Borrowing By-law of the Company, resolutions of the Board of Directors of the Company, certificates of officers of the Company and such other documents as we have considered relevant for the purposes of this opinion. We have also received and relied upon the following opinions, each dated condurrently herewith: (a) the opinion of Messrs. Fraser & Beatty of Toronto, Ontario, as to the offer and sale of the Notes in the Province of Ontario; (b) the opinion of Messrs. Thompson, Dilts & Co. V A U < ; H A N , W I I J - S A M I I K I ' I I V -2-1 5 7 of Winnipeg, Manitoba, as to the offer and sale of the Notes In the Province of Manitoba; (c) the opinion of Messrs. Saucier, Jones, Peacock & Co. of Edmonton, Alberta, as to the offer and sale of the Notes in the Province of Alberta; (d) the opinion of Messrs. Lafleur & Brown of Montreal, Quebec, as to the offer and sale of the Notes in the Province of Quebec. Based upon and subject to the foregoing, we are of the opinion that: ( 1) The Company has been duly incorporated and is a valid and subsisting corporation in good standing under the laws of Canada. ( 2 ) A l l necessary corporate action has been taken by the Company and the Directors thereof to authorize the ob-taining of loans by the Company, the execution of Notes for such loans and the sale, discount and re-discount of Notes to any purchaser. ( 3 ) The specimen Notes, copies of which are i n -cluded in the Company's Offering Memorandum (the "Memorandum") dated June 3 0 , 1 9 6 9 , are satisfactory in form and, when duly executed by the President or any Vice President together with the Secretary or an Assistant Secretary of the Company and delivered by the Company, the Notes in such form w i l l be valid and binding obligations of the Company in accordance with their terms. (h) Based on the earnings of the Company for the five years ended December 3 1 , 1 9 6 4 to 1 9 6 8 inclusive, and on the dividends paid by the Company on i t s ordinary shares in each of such five years and in the f i r s t quarter of 1 9 6 9 , and on the dividends paid by the Company on i t s preference shares and preferred shares in each of such five years and In the five-month period ended May 3 1 , 1 9 6 9 , the Notes are investments: (a) in which the Canadian and B r i t i s h Insurance Companies Act states that companies registered under Part III thereof may, without availing them-selves for that purpose of the provi-sions of subsection ( 4 ) of section 6 3 of the said Act, invest their funds; and (b) in which The Loan and Trust Corporations Act of Ontario states that trust companies registered thereunder may, without availing 159 APPENDIX B Appendix B c o n s i s t s of a copy of I s s u i n g Commercial and F i n a n c i a l S hort Term Promissory Notes which i s produced by A.E. Ames & Co. L i m i t e d and i s used by t h a t company as an a i d i n the process o f i n t r o d u c i n g the money market to p r o s p e c t i v e i s s u e r s of promissory notes. A . E . A m e s & C o . L i m i t e d 160 ISSUING COMMERCIAL AND FINANCIAL SHORT TERM PROMISSORY NOTES I N D E X Page 1. What i s Commercial and Financial Paper? 2. The Purpose 3- The Advantages k. Basic Financial Requirements 5. Coming to the Market 6. Documentation 7. Operating Procedure 8. What We Provide and Charges 9. Guarantees or Similar 10. Rating Services 11. Description of the Money Market 12 - Ik. Representative L i s t of Short Term Borrowers 15 - 17. Glossary of Terms Appendix I Comparative Rate Graph II Extract from Trust Companies Act III Documents Required for Issuance IV Extracts from Income Tax Act A . E . A m e s & C o . L i m i t e d WHAT IS COMMERCIAL AMD FINANCE PAPER? Commercial Paper is short term unsecured promissory notes of major corporations, either interest bearing or discount notes issued in accordance with the borrowing by-laws of the Corporation for a specific maturity and bearing an interest cost rate agreed upon between the borrower and lender. Maturities vary from demand notes, which can be prepaid on 2k hours notice, to three years. 30-60-90 day notes are most common, however, and constitute approximately 90$ of a l l commercial and financial paper outstanding. Financial Paper is basically the same by application except i t is usual for this paper to be secured by a pledge ofreceivables in excess of 100$ or carries a guarantee of a larger parent. The minimum legal denomination without registration under various Provincial Securities Acts is $50,000 but most borrowers set a minimum of $100,000. Commercial and Financial paper can be issued by any.prime borrower with proven credit acceptance irrespective of whether the borrower is publicly or privately incorporated. These notes are marketed by investment dealers to major institutional and corporate lenders on an agency basis. (A commission being paid by the borrower to the placement dealer for his efforts). A . E . A m e s & C o . L i m i t e d THE PURPOSES Commercial paper is usually issued for working capital pur-poses to finance inventories or receivables. It may also be issued to finance "bumps" in'capital expenditures, which can be financed by this method without being capitalized. A few borrowers have used commercial paper to delay more permanent financing and to gain flexibility in timing over an extended period of time. Finance companies borrow permanently in the short term market to finance receivables, and as part of an overall borrowing strategy. Utilities, including provincial government utilities, also appear to be turning to permanent, short term financing as part of their capital composition. Commercial paper should be considered as a complement to current financing through bank loans and Bankers' Acceptance, and not utilized as a replacement of these normal channels. These three vehicles vary in their relative cost and attractiveness, according to market conditions, and the most attractive at any given time should be used. Historically, commercial paper has been the most economical, but in periods of extreme credit restraint, the spreads tend to narrow. In periods of credit ease interest rates on commercial paper decline more rapidly than the Banks' prime rate, reflecting the true supply and demand factors. A . E . A m e s & Co. L i m i t e d THE ADVANTAGES Commercial and Financial paper has historically been the cheapest method of short term financing. The enclosed graph (Appendix I) compares 30 day prime corporate rates with the prime rate since 1965. The average saving has been j$> excluding commissions. 30 to 90 days has been the normal maturity pattern for industrial borrowers to mini-mize costs, but longer maturities can be arranged to,suit the borrower and are recommended when rates are expected to increase. In this respect, commercial paper provides the only technique of hedging current borrowing costs against excalation in interest rates. There are various strategic advantages to consider. Usually, contingency bank lines to back up commercial paper can be arranged at a minimum cost, consequently, there is an increase in the borrower's short term financing capacity. In a credit squeeze issuing short term paper may inhibit the banks from introducing compensating balances, or utilization fees, which permanently affect the cost of borrowing. It enables a corporation to balance out cash flow distortions and to obtain more flexibility in timing permanent debt.... . Issuing commercial paper as a preliminary to future permanent financing can promote a broader market acceptability and an awareness of a corporation's name among the investors. Regular contact with senior investment dealers and credit markets are further positive advantages. These advantages have repercussions on a corporation's pension funds, acquisitions, general knowledge of the economy, credit conditions, and new financing techniques. A . E. A m e s & C o . L i m i t e d BASIC FINANCIAL REQUIREMENTS Commercial paper borrowing i s available only to prime credits. A minimum equity of $10,000,000 i s required, unless there i s a guarantee or some special subsidiary relationship. Minimum borrowing expectation should be $5,000,000 over a period of two years, or during regular seasons. Unused bank lines (Canadian or International) equal to the amounts expected to be borrowed are essential, and extra lines to back up paper issuance can usually be negotiated at a bank at minimum charge, but on a clear understanding that their use i s to be exceptional. Dividends, or earnings record, over the latest five years, are necessary to establish le g a l i t y for insurance company, pension fund and trust company investments. (See Appendix II)<> In exceptional circumstances, i t may be possible for a corporation who does not qualify under the various Acts, to borrow money via this medium. Obviously, any short term borrowing must be in accord with any trust deed restrictions within the corporate borrowing structure. A prior condition to a l l other requirements for the issuance of Commercial paper i s that a borrower have a SOUND CAPITAL STRUCTURE, GOOD WORKING CAPITAL AND STRONG REPUTABLE MANAGEMENT. A . E . A m e s & C o . L i m i t e d 1 6 5 5 , COMING TO THE MARKET An of f e r i n g memorandum.is prepared p r i o r to any commercial paper borrowing. I t should be available several weeks i n advance of actual requirement to b u i l d up market acceptance. I f there i s a group of dealers, a s e l l i n g group meeting should be held at t h i s time, the d e t a i l s of the o f f e r i n g outlined, and an itemized procedures sheet provided to each dealer, The Manager of a group usually c l a r i f i e s at t h i s stage that he w i l l make a l l preparatory coverage of a l i s t of major i n s t i t u t i o n s ; t h i s l i s t i s given to a l l participants and counters any i n i t i a l d uplication and consequent confusion by the multiple coverage of a l l p a r t i cipants. Borrowings should b u i l d up quickly to the expected l e v e l , and i n i t i a l rates should be set s l i g h t l y above the market to activate t h i s , This establishes the borrower immediately with a broad number of the lenders approached, and captures substantial funds which can henceforth be held on ro l l o v e r s at normal market rates. A . E . A m e s & C o . L i m i t e d DOCUMENTATION An offering memorandum i s prepared, in consultation with the borrower, issuing dealer and company lawyer. The offering memorandum consists basically of five documents (See Appendix III). 1. Resolution of the Corporation, which outlines the maxi-mum amount of notes to be issued and some of the terms such as type of notes, minimum amounts, and terms of maturity. It also authorizes the appointment of certain company o f f i c i a l s as signing authorities.±o these notes._ 2. Extract of General- Borrowing By-laws of the Corporation which merely authorizes a l l types of borrowings, including short term notes. 3 . A Certificate of Incumbency supplying facsimile signatures and t i t l e s of the signing officers to notes. 4. A Legal Opinion supplied by an independent legal firm which states that the borrowing by-laws and resolution have been investigated, and the opinion of the good standing of the corporation, together with the a b i l i t y to borrow by this method. General reference i s made to the Corporation's financial a c t i v i t i e s and any out-standing l i t i g a t i o n . The Opinion also refers to the type of the note to be issued and to the signing authorities. One of the most important sections of the Legal Opinion i s the reference to legality for Insurance Companies and Trust Companies, etc., after due considera-tion of the various Federal and Provincial Acts. 5. Accompanying these documents would be the Financial Statements^ as provided by the Annual Report of the borrower. We have found that the average time for the preparation and completion of these documents i s three to four weeks. To display an expertise and to create a good public relations impact, i t i s our opinion that i t i s to the advantage of the borrower to present these documents i n printed form. (See example). The cost of having 500 sets of documents prepared ranges between $800 - $1,000.00 and i t would be our estimate that, including legal fees, the t o t a l cost of entering the paper market would be a maximum of $1,500„00 - $2,000.00, Once these documents are completed, i t would be the Manager's job, i n consultation with the borrower, to form a small group of senior Money Market dealers to assist i n marketing. The size of this group would depend upon the amount of outstandings that have been authorized. A . E . A m e s & C o . L i m i t e d OPERATING PROCEDURE This section i s to provide a general idea of day-to-day operations when issuing commercial paper, A completely detailed check l i s t of operating procedures i s available once the decision to issue paper has been made, and i n d i v i d u a l written procedures are prepared to promote c l a r i t y and e f f i c i e n c y . Each morning at 8;^5 - 9%00 a,m„ our trading desk would confirm with the borrower his d a i l y requirements f o r funds (including maturing notes). Interest rate structure would be recommended and agreed upon at t h i s time. Details of a l l negotiated notes (including rate, maturity and r e g i s t r a t i o n ) would be given to the borrower around 1.1:00 a,m, f o r issuance. At approximately 12:30 p,m. our messenger would a r r i v e at the borrower's o f f i c e to pick up the notes and exchange cheques. The time of h i s a r r i v a l would determine the l a t e s t time at which a l a t e order could be booked. Any short f a l l i n the borrower's requirements would be met by temporary bank borrowing, or by issuing a demand note to A. E. Ames & Co, Limited which would be redeemed upon future sales. Any surplus above the borrower's requirements could be reinvested on a aemand basis i n acceptable credits and used to meet maturities. • I f a group of dealers is involved, i t i s recommended that one be appointed j^nager, whose r e s p o n s i b i l i t i e s would be, i n part, to l i a s o n with the borrower and the group, the cash requirements and rates each day thereby eliminating unnecessary phone c a l l s to the borrower. In a group, individual dealer t o t a l of outstanding notes should be made available each month to a l l members. Commissions are b i l l e d to the borrower monthly or f o r other periods by mutual consent. I t has-, become recent practice f o r a borrower to arrange f o r a l l notes to be delivered through a Chartered Bank, af t e r counter signature. This system provides many advantages, but mainly, notes .• can be held i n a l l f i n a n c i a l centres, such as Montreal, Toronto and Vancouver, to be available for same day delivery. This service i s available through most Chartered Banks f o r a nominal cost of approxi-mately $10.00 per note issued, including acceptance and payout of funds and transfer of funds from one point to another. Once a short term note operation i s set up i t can be handled s a t i s f a c t o r i l y by a good junior o f f i c e r f o r amounts up to $10,000,000. Even f o r larger amounts up to $.100,000,000 the procedure i s simple and requires l i t t l e expertise or a great addition to normal finance depart-ment Staff., • . ; 168 8. A . E . A m e s & Co. L i m i t e d WHAT WE PROVIDE AND CHARGES Our basic function i s to keep the borrower advised at a l l times on market conditions and to suggest rate structures and to market the required notes. We assist in the preparation of,the i n i t i a l documents and supervise their form and wording, but printing and legal opinions are at the borrowers expense, A l l advertisements are at our expense. The i n i t i a l promotion of the corporate name to lenders i s our responsibility, but the borrower may be asked to participate on a limited basis, dependant upon the promotional requirements of the borrower. Day-to-day financing, when maturities are not exactly covered, are best handled by bank borrowing. A, E„ Ames & Co. Limited can bridge these gaps by buying demand notes i n some circumstances. (These notes to be replaced by term money as i t becomes available). Delivery on both new notes and the payment of old notes can be handled by our Company at our expense or by arrangements with a Chartered Bank, (see page 7 ) . Regular discussions are held between the borrower and our senior department staff on changing credit conditions, alternative forms of borrowing, and methods of operation. OUT charges are either or of 1% per annum on the par value of notes sold. The rate for corporation borrowers i s jffo which reflects the commission expense not being a deductible item for tax purposes. (See Appendix IV). In cases of small amounts or longer terms, however, the charge may be $ 0 per annum. Finance companies are charged of 1% per annum which ijs a tax-deductible expense. A . E . A m e s & C o . L i m i t e d GUAPANTEES OR SIMILAR The normal guarantee i s unconditional as to p r i n c i p a l and i n t e r e s t , and i s usually inscribed on the back of the note. There may be some choice as to who the guarantor i s . Captive finance companies may be guaranteed by the parent manufacturing or mer-chandising corporation, or by a parent foreign finance company which, i n turn, i s a subsidiary of the ultimate operating company. For instance, Simpson-Sears Acceptance Company Limited i s guaranteed by Simpson's~Sears Company Limited, but General Motors Acceptance Corp. of Canada Limited i s guaranteed by General Motors Acceptance Corp. When a parent company cannot guarantee debt f o r t r u s t deed, or other reasons, a s i m i l a r effect can be achieved in. a "solvency agreement" or "keep f i t covenant". In these cases, the parent company covenants with a trustee to maintain c e r t a i n debt-equity r a t i o s i n the subsidiary. Any decline i n the borrower's net worth i s thereby made good by the parent infusing new c a p i t a l or paying o f f the debt to.main-t a i n the covenanted r a t i o s . The p o s s i b i l i t y also exists of trusteeing very low r i s k receivables, such as Export-Credit Insurance Corporation guaranteed notes, and issuing notes i n some proportion to the market value of these notes. A . E . A m e s & Co. L i m i t e d RATING SERVICES There are two rating services available in Canada for commercial and finance paper. National Credit Office, a subsidiary of Dun and Bradstreet, rates borrowers "prime", "desirable", "satisfactory", or "acceptable" for an annual fee of approximately $^ 00,00. Standard & Poor's Corporation rates corporations Al, A 2 , A3, B, C, D, for a variable fee dependent upon the analysis required. Either of these services are recommended since the investing public i s becoming more aware of their existence and are beginning to rely on such ratings. If U.S. pay notes are to be issued, it would be mandatory to receive a "prime" rating from one of these services since so many of the major investors in the U.S.A. are controlled by by-Laws requiring such a rating. A . E . A m e s & Co. L i m i t e d DESCRIPTION OF THE MONEY MARKET 1 ° j^g^_?,^t'^.S^P?J^-i_^XJ^Mg°^C. 20 P r o v i n c i a l & Municipal Governments 10 Banks l8 Major Trust Companies & Mortgage Corporations 40 Major Corporations 6 L i f e Companies 18 Major Finance Companies 15 Money Market Dealers - 6 or 7 active 2. Approximate .Amounts Outstanding M i l l i o n s of Dollars _____ %  1962 1968 1967 Increase Govt, of Canada Treasury B i l l s 2,895 2,825 2,455 18 Short Canadas (under 3 years) 5,191 800 4,651 3,895 33 Prov, & Mun, Notes & T„ B i l l s 700 500 60 Chartered Bank Deposits 18,U81 17,858 15,280 21 Bankers' Acceptances 182 • 112 149 22 Bank Swap Deposits 1,577 817 904 74 Trust Companies - G I C's 3,207 2,739 17 Commercial borrowers 900 U50 320 195 Sales Finance & Consumer Loan 1,453 1,219 912 59 Five major dealers would account f o r 75-80$ of the market's volume with a much larger number around the periphery. The p r i n c i p a l lenders to the market are corporations, t r u s t companies, banks, insurance companies, governments, mutual and closed-end funds, pension funds and public i n s t i t u t i o n s , American lenders i n these categories are a major factor i n the market, accounting f o r up to 25$ (est,) of the t o t a l amount outstanding. A . E . A m e s & Co. L i m i t e d REPRESENTATIVE LIST OF SHORT TERM BORROWERS The following borrowers have signified their intention of u t i l i z i n g A. E. Ames & Co. Limited's f a c i l i t i e s from time to time to assist i n their short term requirements from the Canadian markets. Governments (including Crown Corporations) B i l l s & Notes Commission des Ecoles Catholiques de Montreal Province of Manitoba Province of New Brunswick Province of Newfoundland Province of Nova Scotia Province of Prince Edward Island Province of Saskatchewan Hydro Electric Commission of Ontario Manitoba Hydro-Electric Commission Newfoundland and Labrador Power Commission The Protestant School Board of Greater Montreal Quebec Bydro-Electric Commission City of London, Ontario City of Montreal, Quebec City of Vancouver, British Columbia The Corporation of the D i s t r i c t of North Vancouver The Municipality of Metropolitan Toronto The Metropolitan Corporation of Greater Winnipeg Corporations Atlantic Sugar Refineries Company Limited B. C. Central Credit Union Bell Canada B„ F. Goodrich Canada Limited Bri t i s h Columbia Packers Limited Building Products of Canada Limited Canada Packers Limited Canadian General Ele c t r i c Company Limited Canadian Industries Limited Canadian Pacific Securities Limited Canron Limited Collins Radio Company of Canada Limited The Consumers' Gas Company D i s t i l l e r s Corporation Limited Dominion. Bridge Company Limited Dominion Textile Company Limited DuPont of Canada Limited Firestone Tire & Rubber Company of Canada Limited Genstar Limited Grain Companies Great Canadian O i l Sands Limited A . E . A m e s & Co. L i m i t e d Honeywell Holdings Limited Hudson's Bay Company Imperial O i l Limited Imperial Tobacco Company of Canada Ltd. I n d u s t r i a l L i f e Insurance Company Joseph E. Seagram & Sons Limited K e l l y , Douglas & Company, Limited MacMillan Bloedel Limited Maple Leaf M i l l s Limited National Cash Register Company of Canada Limited Petrofina Canada Ltd. Robin Hood Multi-Foods Limited Robert Morse Corporation Limited R o l l s Royce of Canada Ltd. Rupert's Land Trading Company Simpsons Limited Standard Brands Limited Steinberg's Limited Union Gas Company of Canada Limited Uniroyal Ltd. Finance Companies Associates Acceptance Company Limited Aveo F i n a n c i a l Services Limited B e n e f i c i a l Finance Co„ of Canada Canadian Acceptance Corporation Limited Canadian General E l e c t r i c Credit Limited Chrysler Credit Canada Ltd. Commercial Credit International Limited The To Eaton Acceptance Co. Limited General Motors Acceptance Corporation of Canada Limited IAC Limited International Harvester Credit Corporation of Canada Limited Laurentide F i n a n c i a l Corporation Ltd. Massey Ferguson Finance Company of Canada Limited Niagara Finance Company Limited Personal Finance Company Ltd. RoyNat Ltd. Simpsons Sears Acceptance Company Limited Traders Group Limited Transamerica F i n a n c i a l Corporation of Canada Limited United Dominions Corporation (Canada) Limited Trust Companies (Guaranteed Investment C e r t i f i c a t e s ) & Mortgage Corporations Canada Permanent Trust Company Canada Permanent Mortgage Corporation Canada Trust Company Credit Foncier Franco-Canadien Crown Trust Company Guaranty Trust Company A . E . A m e s 8c L i m i t e d International Trust Company Kinross Mortgage Corporation Montreal Trust Company National Trust Company The Royal Trust Company The Royal Trust Company Mortgage Corporation Societe de Fiducie du Quebec Trust General du Canada V i c t o r i a & Grey Trust Company Waterloo Trust Company Bank Deposit Receipts Canadian Imperial Bank of Commerce The Royal Bank of Canada Bank of Montreal The Toronto-Dominion Bank The Bank of Nova Scotia Banque Canadienne Nationale La Banque Provinciale du Canada The Mercantile Bank of Canada Bank of B r i t i s h Columbia A . E. A m e s & C o . 175 15. GLOSSARY OF TERMS MONEY MARKET Similar to any other market - i t i s a central point of contact for persons who have a desire to exchange a commodity. Specifically the Money Market i s the exchange of cash or value representing cash. Many vehicles are u t i l i s e d in this, exchange, vi z - Government of Canada Treasury B i l l s , "short term bonds (maturities less than three years), Provincial and Municipal short term securities, bank and trust company short term notes, commercial and finance company notes. SHORT TERM COMMERCIAL & FINANCE PAPER Commercial paper i s the unsecured promissory notes issued by various companies of established reputation and financial soundness. Finance paper i s very often secured by pledge of 112$ of receivables or i s guaranteed by a U.S. parent. DAY_TOJDAY LOANS (D.D.L.'S) Are special lew cost loans granted to the 15 Money Market dealers by the Chartered Banks to enable the dealers to carry Canada Treasury B i l l s and short Government issues under three years. It also enables banks to invest their cash float and D.D.L.fs qualify as secondary reserves i n the banking system. CALL LOANS • . ' Special loans granted by banks and other financial institutions to a l l dealers to enable banks to invest over reserves of cash and dealers to carry a l l inventories. B.D.N., B.D.R., G.I.C. Bearer Discount Notes, Bank Deposit Receipts, Guaranteed Investment Certificates, are the short term notes issued by banks and trust companies. AGENCY TRANSACTIONS This i s the most simple and frequent type of deal. The dealers act as the agents who bring together the borrower and lender. $1 million invested for one day at brings a return of $226.00. For one month the return i s $7,007.00. A . E . A m e s & C o . L i m i t e d 16. i 3UY-BACK Jhen paper i s sold out of dealer inventory for a specified period of time, lot necessarily f o r the f u l l term of the note, at a given y i e l d and simultaneously repurchased f o r the termination date. ffiLAYED DELIVERY ftien an account knows that he w i l l have "X" amount of funds f o r investment it some future s p e c i f i e d time and the current market rates are a t t r a c t i v e .n his opinion, a note i s sold now f o r delivery i n the future. U n t i l such ;ime of delivery the paper i s c a r r i e d i n our inventory on a c a l l loan, is u a l l y i n the "Country Banks" or a l t e r n a t e l y the paper, f o r the short >eriod of time, can be sold on a buy-back with another account. •IANKING ARRANGEMENTS .'his i s used to a s s i s t an account should he be required to make unforeseen leavy c a p i t a l outlays f o r short periods of time during the term the note i s tutstanding. The broker w i l l bank the note f o r the account charging a rate ibove the c a l l loan rate as a recompense for tying up his own l i n e s of credit. I ALL FEATURES !his i s used to accommodate an account who feels he might need the funds Luring the term of the note - a c a l l feature i s put on the note f o r a s p e c i f i e d Late which e n t i t l e s the account to c a l l the note p r i o r to maturity - usually it a penalty from the established rate. The c a l l feature can be put on the lote either by the issuer or the s e l l i n g broker. >OUGHNUT 'his i s arranged to accommodate an account who wishes to buy a piece of paper 'or a s p e c i f i e d term but f o r certain interim periods within the term of such : note does not want to have i t on his books, i . e . , f o r reporting periods ->r periods of heavy c a p i t a l outlays. it the time of the sale of the notes i t i s s p e c i f i e d that the s e l l i n g broker i l l buy back the note on the day desired and r e s e l l i t to the account when .he term of such "hole" i s terminated. This term i s usually three days to a reek. JACK TO BACK h i s i s generally employed to accommodate a lender of funds whose r e s t r i c t i o n s :ompel him to deal i n the generally lower rate paper issued by t r u s t companies, iank deposits, etc. A back to back i s arranged with such i n s t i t u t i o n s by s e l l -ng to them finance or s i m i l a r type paper bearing a much higher rate of interest •nan t n e i r own paper enabling them to take a margin of p r o f i t , usually a ^ of .nd to issue a note of t h e i r own at higher rates than they would otherwise pay 'or cash. io.oo£ *K:».Si*i2'2 3 s A . E A m e s & C o . 178 APPENDIX II EXTRACT FROM: TRUST COMPANIES ACT Section 68 (1.1(g) debentures or other evidences or indebtedness of a corporation incorporated in Canada that has paid regular dividends on its preferred or common stock for a term of at least five years immediately pre-ceding the date of investment in such debentures or other evidences of indebtedness; THE LOAN AND TRUST CORPORATIONS ACT (ONTARIO) Section 137 (l)(h) the bonds, debentures or other evidences of indebted-ness of any company or bank that has paid regular dividends on its preferred or on its common stocks for not less than five years immediately preceding the date of the purchase or investment, or the bonds, debentures or other evidences of indebtedness of any company or bank that are guaranteed by a company or bank that has paid regular dividends on its preferred or on its common stocks for not less than five years immediately preceding the date of the purchase or investment, provided that at the date of the purchase or investment the amount of bonds, debentures and other evidences of indebtedness so guaranteed is not in excess of 50 per cent of the amount at which such preferred or common stocks, as the case may be, are carried in the capital stock account of the guaranteeing company or bank, 1 7 9 APPENDIX I I I A. E . A m e s & C o . (Also r e f e r to accompanying specimen o f f e r i n g memorandum) L i m i t e d DOCUMENTS REQUIRED FOR THE ISSUANCE OF SHORT TERM NOTES 1. Independent l e g a l opinion as to the constitution and the powers of the company to borrow. 2. C e r t i f i e d copy of the By-law, authorizing the company to borrow by way of promissory note. 3. C e r t i f i e d copy of the Resolution, appointing the signing a u t h o r i t i e s , and form of note to be issued, k. Audited annual statement and quarterly statements i f available, 5., C e r t i f i c a t e of Incumbency and facsimile signatures of signing o f f i c e r s . 6. Specimen of notes to be issued. In addition to the above, we require, 1. The current bank borrowing and the t o t a l of bank cr e d i t l i n e s . 2. Total amounts of notes outstanding at least once per month. A . E . A m e s & Co. L i m i t e d EXTRACTS FROM INCOME TAX ACT Deductions Allowed in Computing Income Section 11 (l)(c) Interest - an amount paid i n the year or payable in respect of the year (depending upon the method regularly followed by the taxpayer in computing his income), pursuant to a legal obligation to pay interest on (i) borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income from which would be exempt or to acquire an interest i n a l i f e insurance policy), ( i i ) an amount payable for property acquired for the purpose of gaining or producing income therefrom or for the purpose of gaining or producing income from a busi-ness (other than property the income' from which would be exempt or property that i s an interest i n a l i f e insurance policy), or ( i i i ) an amount paid to the taxpayer under (a) an Appropriation Act and on terms and conditions approved by the Treasury Board for the purpose of advancing or sustaining the technological capability of Canadian manulactrumg or other industry, or (b) the Northern Mineral Exploration Assistance Regulations made under an Appropriation Act that provides for payments in respect of the Northern Mineral Grants Program, or a reasonable amount i n respect thereof, whichever i s the lesser. 181 APPENDIX C Th i s Appendix i s composed of co p i e s of r e c e n t i s s u e s of the weekly money market n e w s l e t t e r s produced and d i s -t r i b u t e d by A.E. Ames & Co. L i m i t e d and Wood Gundy S e c u r i t i e s L i m i t e d . March 4, 1971 NEW CANADA ISSUE Prel iminary deta i ls of new Government of Canada f inanc ing to refund $225mill ion 6% Apr i l 1, 1971 and $200 mil l ion 6%% Apr i l 1, 1971 should be re leased on March 12.The Chartered Banks appearto hold approximately 40% of the two maturities and the Bank of Canada $100 to $150 mi l l ion . From $600 mi l l ion in requirements est imated as recently as two months ago, Ottawa 's residual cash needs for the f i s c a l year ending March 31, 1971 may now be near zero. A number of developments seem to be re-spons ib l e , the most s ign i f icant of which is the performance of Canada Savings Bonds. Between December 2 and February 24 Canada Savings Bonds outstanding increased by $112 mi l l ion whereas net redemptions nor-mal ly approachthat amount during the same period in any given year. Secondly , Ottawa ra ised $150 mi l l ion new ca sh with its February 15 long term issue and continues to take in $10 mi l l ion net each week v ia in -c reases in the treasury bi l l auct ion. Certa in f i s ca l 1970—71 federal government expenditures, moreover, are l ike ly to be carr ied into the next f i s ca l year. In this latter context Finance Minister Benson has rev ised f i s ca l 1971—72 c a s h requirements upwards, from $1.9 to $2 b i l l i on . Desp i te the foregoing, and the current comfortable level of government ba lances ($1.7 b i l l ion) , Ottawa may : ra ise some new money with this refunding. If the 1971 CSB campaign y ie lds $800 mi l l ion, some $1.2 b i l l ion of requirements must be f inanced in the next 12 months. A l s o cons iderat ion must be given at some point to pre-refunding a portion of the $1 b i l l ion A Y A % September 1, 1972 s t i l l outstanding. With this in mind,and noting the recently revived po l i cy of monetary ease , the Apr i l f inancing might be set at $550 mi l l ion. In se lec t ing appropriate maturit ies, it should be noted that the chartered banks purchased some $90 mi l l ion Canadas in the two weeks ended February 24, the bulk of which appeared to be intermediate term bonds. Th is implies that a reasonable degree of term extension might be success fu l l y attempted. Apr i l 1974 seems a good date for a money market anchor i ssue and, coupled with a 6 — 8 year bond, would form an attract ive package. Brian Steel Government of Canada Treasury Bills and Short Term Bonds / Finance and Acceptance Company Notes/ Commercial Paper / Provincial Treasury Bills / Provincial Direct and Guaranteed Notes / Municipal Notes / Bankers Acceptances / Chartered Bank Bearer Deposit Notes and "Swapped" Deposits / Euro-Dollar Deposits / Collateral Loans. RATES - 24 HOUR DEMAND TO 1 YEAR IN TERM 183 C A N A D I A N F I N A N C E COMPANIES C A N A D I A N PAY + Genera l Motors A c c e p t a n c e Co rp . of C a n a d a t Ford Motor Cred i t C o . of Canada t A v c o F i n a n c i a l Se rv i ces t Bene f i c i a l F inance C o . of C a n a d a t C a n a d i a n A c c e p t a n c e Corp . t Commerc ia l C red i t International L td . t I A C L im i ted Laurent ide F inanc ia l Corpora t ion L td . M a s s e y Ferguson F inance C o . of C a n a d a L td . N iaga ra F inance C o . L td . Sperry Rand F inanc ia l Co rp . C a n . L td . t T. Eaton A c c e p t a n c e Company L im i ted Traders Group L td . T ransamer ica F inanc ia l Co rp . Canada t U n i o n A c c e p t a n c e Corp . L td . Un i ted Domin ions Co rp . Canada L td . U.S. PAY IAC L td . N iaga ra F inance C o . L td . COMMERCIAL PAPER Be l l Canada B P O i l L imi ted t B r i t i sh Co lumb ia Packe rs L imi ted C a f o L imi ted C a n a d i a n General E lec t r i c Company L imi ted Demand 1-29 days 30-59 days 60-89 days 90-119 days 120-179 days 180-269 days 270-365 days 5 5/a 4/a _ 41/2 4V2 4% 4% 5 5 — 4% 4% 4% 454 4% 4% _ m 4% 5 5 5/a 5/s _ 4% 5 5 5/s 5/a * * * * * 5/8 5/8 * * * 5/8 5% 5/a 5/a — m 4% 5 5 5/a 5/8 5 5/a 5'/4 5'/2 5% 5Ya 5/a 536 5% 5% 6 6 6 6 ~ 5 5 5/8 5/8 5!4 5% _ _ _ — — 4% 4% 4% 4% 4% — 4% 5 5 5/8 5/8 * 5 5 5/s 5/8 5 5 5/a 5/a 51/4 51/2 5/2 — 5 5 5/8 5/8 5% 5/4 4.00 4.00" 4.125 4.50 4.50 4.50 - 4.125 4.125 4.25 4.625 4.625 4.625 5 5 5 5/a _ _ _ — 5/a 5'/4 - - - - -4% C a n a d i a n P a c i f i c Secu r i t i es L imi ted t _ 5 5 4% 4% 5/a Canron L imi ted 5/8 5/a 5J4 _ _ _ _ Consumers G a s Company 4/8 4/a 5 _ _ _ John Deere L imi ted t 5/8 _ _ D i s t i l l e r s Corporat ion L im i ted t 4/8 4/e 5 5/4 _ Domin ion Tex t i l e Company L imi ted 5 5 5/8 _ _ _ Dupont of Canada L imi ted 4% 4% 4/a _ _ Federa l Gra in L imi ted 5M 5% 5/8 _ _ _ Genera l Foods L td . 5 5 5/a _ _ _ _ GenStar L imi ted 5/8 5/s 5/4 — _ _ Imperial O i l L imi ted _ 4/2 4% - - _ _ Imasco L imi ted 5 5 5/a _ _ _ _ _ Internat ional N i c k e l Company of C a n a d a , L imi ted _ K e l l y Doug las & Company L imi ted 5% 5% _ _ _ M a c M i l l i a n Bloedel L td . _ 5 5/8 5/4 _ — — Maple Leaf M i l l s L imi ted 5/a 5/a 5J4 - - -Noranda M ines L imi ted 4% 4% 4/a — — - - -Petro f ina Canada L imi ted _ _ 5% _ _ _ P h i l i p s E lec t ron i cs Industr ies L imi ted t _ _ _ Robin Hood Mu l t i foods L imi ted 5/a 5/a 5/4 _ _ _ _ Royal Trust Mortgage Corporat ion _ 5/4 5/a 5% 5/a _ Roymor L imi ted 5 5/a _ _ _ _ Roynat L e a s i n g L td . 5/a 5/a 5% _ _ _ _ _ Roynat L td . 5 5 5/a _ _ _ S a s k a t c h e v a n Wheat Pool 5/2 5/2 _ _ — _ _ _ Simpsons L imi ted _ 4/a 4/a 4/a _ _ Ste inbe rg ' s L im i ted 5 5 5/8 _ _ _ _ _ Texaco Canada L imi ted 4/a 4/a 5 5 _ _ _ Un i ted Gra in Growers L im i ted 5/4 5!4 5M _ _ - - -UniRoya l L td . t _ - -Woodward Stores L td . - - - - - - -+ D iscoun ted Y ie l d A v a i l a b l e : t Parent Guarantee: * Rates on A p p l i c a t i o n P R O V I N C I A L A N D M U N I C I P A L NOTES Ontar io Hydro _ _ 4.75 5.10 5.20 5.20 5.30 5.40 Quebec Hydro - - 5.00 5.10 5.20 5.25 5.35 5.45 Saska tchewan - - - - 5.25 ~ - -A lbe r t a M u n i c i p a l F inanc ing Co rp . - - - - 5.25 - — — R A T E S - T O 1 Y E A R I N T E R M ( C O N T ' D ) 1-15 16-29 30 60 90 180 270 365 CHARTERED BANKS DAYS DAYS DAYS DAYS DAYS DAYS DAYS DAYS C D N . D O L L A R DEPOSITS 3 . 7 5 4 . 5 0 4 . 9 0 4 . 9 0 4 . 9 0 5 . 0 0 5 . 0 0 5 . 0 0 C D N . D O L L A R " S W A P P E D " DEPOSITS 5 . 1 0 5 . 1 0 5 . 2 0 5 . 7 0 5 . 7 5 6 . 0 0 TRUST C O M P A N I E S 5 . 0 0 5 . 2 5 5 . 2 5 5 . 5 0 5 . 5 0 5 . 5 0 BANKERS A C C E P T A N C E S Bid _ _ 4 . 9 5 5 . 0 0 5 . 0 5 _ _ Offered 4 . 7 5 4 . 8 0 4 . 8 5 4 . 9 0 4 . 9 5 - - -R A T E S - 1 Y E A R T O 6 Y E A R S 1-1'/2 •\yr2 2-2Vi 254-3 3-4 4-5 5-6 Years Years Years Years Years Y e a r s Years CHARTERED BANKS 5 % 5 % 6 ! 4 &A 63A Q3A _ F I N A N C E C O M P A N I E S S3A 5 % Q% &A 1 1 Th TRUST C O M P A N I E S 6% 6YA 6 1 / 2 6 1 / 2 1 7 V S S E L E C T E D C A N A D I A N F I N A N C I A L S T A T I S T I C S Recent Week CHARTERED BANKS Secondary Reserves More L iqu id A s s e t s Day To Day Loans C a l l Loans To Investment Dea le rs Genera l Loans L o a n s / D e p o s i t s MONEY SUPPLY (%) (Min C a s h & Second. (%) Req. 15 .27% Feb.) ($ Mlns. ) ($ Mlns. ) (S Mlns. ) (%) ($ Mlns. ) G O V T . OF C A N A D A B A L A N C E S ($ Mlns.) A V A N I O L T A B L E Prev. Week 1 6 . 5 3 0 . 9 3 0 5 . 4 7 3 . 1 5 , 9 9 0 . 6 3 . 9 3 2 , 3 1 6 . 1 , 7 8 9 . Prev. Month 1 6 . 2 3 0 . 6 3 4 1 . 4 4 6 . 1 5 , 8 1 5 . 6 4 . 5 3 1 , 9 2 3 . 1 , 5 0 2 . G O V E R N M E N T O F C A N A D A T R E A S U R Y B I L L S • Due Bid Asked Date % % 1 week 1 2 Mar. 4 . 8 0 3 . 8 0 1 4 week 2 week 1 9 Mar. 4 . 5 0 3 . 8 0 1 5 week 3 week 2 6 Mar. 4 . 2 0 3 . 8 0 1 6 week 4 week 2 Apr. 4 . 1 0 3 . 8 0 1 7 week 5 week 8 Apr. 4 . 0 0 3 . 8 0 1 8 week 6 week 1 6 Apr. 4 . 0 0 3 . 8 0 1 9 week 7 week 2 3 Apr. 3 . 9 5 3 . 8 0 2 0 week 8 week 3 0 Apr. 4 . 0 0 3 . 8 5 2 1 week 9 week 7 May 4 . 0 5 3 . 9 0 2 2 week 1 0 week 1 4 May 4 . 0 0 3 . 9 0 2 3 week 1 1 week 2 1 May 4 . 0 0 3 . 9 0 2 4 week 1 2 week 2 8 May 4 . 0 0 3 . 9 0 2 5 week 1 3 week 4 Jun. 4 . 0 0 3 . 9 5 * 2 6 week Due Date 1 1 Jun. 1 8 Jun. 2 5 Jun. 2 Jul . 9 Jul . 1 6 Jul. 2 3 Jul. 3 0 Jul. 6 Aug. 1 3 Aug. 2 0 Aug. 2 7 Aug. 3 Sep. Year Ago 1 5 . 6 2 5 . 4 2 7 6 . 1 7 3 . 1 4 , 8 7 1 . 6 9 . 3 2 8 , 6 3 0 . 1 , 1 0 7 . Bid % 4 . 1 0 4 . 1 0 4 . 1 0 4 . 1 0 4 . 1 0 1 0 1 0 1 0 0 5 0 5 0 5 0 5 0 3 Asked % 3 . 9 5 3 . 9 5 3 . 9 5 3 . 9 5 3 . 9 5 3 . 9 5 3 . 9 5 3 . 9 5 3 . 9 5 3 . 9 5 3 . 9 5 3 . 9 5 3 . 9 8 Latest Maturities G O V E R N M E N T O F C A N A D A B O N D S T O 3 Y E A R S I N T E R M BID A S K YIELD % ISSUE BID ASK YIELD % ISSUE BID ASK YIELD % 1 A p r . 1 9 7 1 1 0 0 . 0 0 1 0 0 . 0 7 5 . 1 2 6 1 5 D e c . 1 9 7 1 1 0 0 . 7 5 1 0 0 . 8 5 4 . 8 6 7 1 F e b . 1 9 7 3 1 0 3 . 6 0 1 0 3 . 7 0 4 9 5 1 A p r . 1 9 7 1 1 0 0 . 0 0 1 0 0 . 1 0 5 . 0 4 &A 1 A p r . 1 9 7 2 1 0 1 . 6 0 1 0 1 . 7 0 4 . 8 7 7 1 A p r . 1 9 7 3 1 0 3 9 0 1 0 4 0 0 4 9 5 1 June 1 9 7 1 1 0 0 . 6 0 1 0 0 . 7 0 5 . 1 4 TA 1 Apr. 1 9 7 2 1 0 2 . 3 0 1 0 2 . 4 0 4 . 9 5 6 / 2 1 Jul. 1 9 7 3 1 0 3 . 3 5 1 0 3 . 4 5 4 . 9 2 1 June 1 9 7 1 9 9 . 9 0 1 0 0 . 0 0 4 . 9 7 4% 1 Sept. 1 9 7 2 9 9 . 1 0 9 9 . 2 0 4 . 8 1 6 % 1 Jul. 1 9 7 3 1 0 3 . 9 0 1 0 4 0 0 4 9 1 1 O c t . 1 9 7 1 1 0 0 . 7 0 1 0 0 . 8 0 4 . 9 0 S% 1 5 D e c . 1 9 7 2 1 0 0 . 4 5 1 0 0 . 5 5 4 . 9 3 5 1 Oct 1 9 7 3 1 0 0 1 0 1 0 0 2 0 4 9 2 1 O c t . 1 9 7 1 1 0 1 . 7 0 1 0 1 . 8 0 4 . 8 3 8 1 F e b . 1 9 7 3 1 0 5 . 3 0 - 5 . 0 6 &A 1 D e c . 1 9 7 3 1 0 3 . 2 0 1 0 3 . 3 0 4 ^ 9 5 This is not and under no circumstances is this memorandum to be construed as an offering of any securities. MONEY MARKET SUMMARY 185 Last Last Las t Las t L a s t Last Today Week Month Year Today Week Month Year B A N K RATES C H A R T E R E D B A N K DEPOSITS Canada 5/4 5/4 6 8 C D N . Dol lar 3 Month 4.90 5.00 5.75 7.50 U. S. * 4% 4 3 / 5 6 " S w a p p e d " 3 Month 5.20 5.50 6.25 8.55 U. K. 7 7 7 8 REPRESENTATIVE PRIME RATES SHORT TERM PAPER Canada 61/2 6V2 7 81/2 Canada 3 month 5.00 5.00 6.00 8.25 U. S. 5% 5% 6 81/2 U. S. 3 month 4.00 4.00 4.50 7.75 TREASURY BILLS FORWARD E X C H A N G E H E D G E RATES ( A V G . TENDER) % ( A N N U A L Y I E L D B A S I S ) Canada 3 month 3.98 4.06 4.79 7.52 Canada To U. S. 3 month + .88 + 1.12 + 1.00 + .20 6 month 4.03 4.08 4.94 7.48 U. S. To Canada 3 month - .96 -1.20 -1.08 - .26 U. S. 3 month 3.34 3.49 4.11 6.86 U . K. 3 month 6.78 6.78 6.78 7.37 YIELD DIFFERENTIAL C A N . - u. s. F E D E R A L G O V E R N M E N T B O N D S BANKERS A C C E P T A N C E S 5 year .34 .36 - .15 .82 Canada 3 month 4.95 5.15 6.10 8.35 LONG TERM (Average) .70 . .76 .67 1.66 U . S. 3 month 3.875 4.125 4.50 8.125 • C A N A D I A N D O L L A R In terms of U . S . t 99.38 99.38 99.23 93.23 F e d e r a l R e s e r v e B a n k o f N e w Y o r k ' + c f I .M .F . P a r i t y R a n g e 9 1 . 5 7 5 - 9 3 . 4 2 5 T Former 1 ^ ( O p e r a t i o n a l R a n g e 9 1 . 7 4 - 9 3 . 2 4 ' THE FOREIGN EXCHANGE MARKET 1 Month 2 Months 3 Months 6 Months 9 Months 1 Year H E D G E RATES * Canada to U. S. U. S. to Canada - .84 -1.18 + .84 - .96 + .88 - .96 + .74 - .80 + .60 - .70 + .58 - .66 R E L A T I V E " C O V E R E D " SHORT TERM YIELDS G O V E R N M E N T TREASURY BILLS Canadian invest ing Amer ican invest ing in U. S. in Canada 3.84 2.67 4.02 2.9 4 4.14 2.99 4.10 3.20 F I N A N C E C O M P A N I E S ( E q u i v a l e n t C r e d i t s ) Canadian invest ing in U. S. Amer ican invest ing in Canada C O M M E R C I A L PAPER ( E g v i v a i e n i c r e d i t s ) Canadian invest ing in U. S. Amer ican invest ing in Canada C A N A D I A N B A N K - U . S . D O L L A R DEPOSITS Canadian Residents U. S. Residents Third Country Residents E U R O - D O L L A R DEPOSITS (in u. s. Terms) U . S. BANKS C A N A D I A N B A N K . * R a t e s in A n n u a l Y i e l d T e r m s P i c k u p + L o s s - F l a t . . . SPOT C A N A D I A N IN U . S. F U N D S SPOT X STERLING IN U . S. F U N D S FREE G O L D PRICE (London Af te rnoon F ix ing) 4.34 3.94 4.59 3.82 4.25 4.25 4.25 4.75 4.75 4.34 4.21 4.58 4.18 4.25 4.25 4.25 5.00 5.00 FRI. 99.34 2.4163 38.78 4.88 4.17 4.88 4.18 4.375 4.375 4.375 5.00 5.00 M O N . 99.25 2.4153 38.75 4.86 4.45 4.74 4.32 5.00 5.00 5.00 5.625 5.625 TUES 99.28 2.4176 38.70 4.97 4.55 4.60 4.42 5.125 5.125 5.125 6.00 6.00 4.59 WED. 99.31 2.4189 38.77 T H U R S . 99.38 2.4184 38.77 186 CANADIAN BANKING RATES AND STATISTICS B A N K R A T E — 5 J 4 % CH A R T E R E D B A N K S ' P R I M E R A T E — 6 % % W/E W/E W/E Mar. 10/71 Mar. 3/71 Feb. 10/71 Day-to-Day Loans Average of Closing Rates 3.70% 3.80% 5.15% Mar. 3/71 Feb. 24/71 ($ Millions) Feb. 3/71 Money Supply $32,538 $32,365 $32,062 General Loans 16,158 16,019 15,843 Call Loans to Investment Dealers 357 373 485 Liquid Asset Ratio 30.6% 30.8% 30.7% UNITED STATES TREASURY BILLS Mar. 9/71 Mar. 2/71 Feb. 9/71 3 Months Bills 3.307% 3.347% 3.845% 6 Months Bills 3.359 3.467 3.839 tng: h"3JIw^ vumm ftw a^"..—.-HU WW WHL t • i * .-fs._* i . . _ J / j . . j>. .1 ^ . 4 "* 1 » »» *. art MARCH 12,1971 FOREIGN EXCHANGE Canadian $ in New York—99.44 (Noon Mar. 12) Hedge rates showing gain (+) or loss(—) annual yield basis 30 days 60 days 90 days 180 days 365 days U.S. $ in Canada -.12% -.30% -.28% -.34% -.36% Canadian i in U.S. +.12% +.18% +.16% +.28% +.32% Eurodollar Deposit Receipts 4.875% 4.875% 5.00% 5.50% 6.25% A . IE. A m e s C o . Limited f 18? M a r c h 1 2 , 1 9 7 1 A n o t h e r r o u n d o f r e d u c t i o n s i n t h e p r i m e l e n d i n g r a t e s o f m a j o r A m e r i c a n h a n k s t o 534-5J^%, b e c a u s e o f w e a k l o a n d e m a n d , c a p p e d a w e e k o f f a l l i n g m o n e y m a r k e t y i e l d s . M o s t s h o r t C a n a d a s f e l l b y % o f 1 % i n y i e l d a n d 1 - y e a r C a n a d a s n o w y i e l d 4 . 5 0 % c o m p a r e d w i t h 7 . 5 0 % a y e a r a g o . T r e a s u r y b i l l s f e l l a n o t h e r 6 4 b a s i s p o i n t s t o 3 . 3 4 % t h e l o w e s t y i e l d a t t e n -d e r s i n c e J u l y , 1 9 6 3 . B a n k b u y i n g w a s e v i d e n t i n t h e m a r k e t a n d d a y m o n e y g o t a s l o w a s 2 . 5 % t h o u g h c u r r e n t l y ( F r i d a y ) i t i s 3 1 4 % - I n t u e f i n a n c e a n d c o m m e r c i a l p a p e r m a r k e t , r a t e s f e l l Y % o f 1 % a n d t r a d i n g w a s l i g h t w i t h l i t t l e d e m a n d f o r f u n d s . T h e d o l l a r e n d e d t h e w e e k a t 9 9 . 4 4 c e n t s U . S . a l t h o u g h i t d i d t r a d e h i g h e r d u r i n g t h e w e e k . I n t h e f o r w a r d m a r k e t t h e d i s c o u n t a t 3 0 d a y s d i s a p p e a r e d a t o n e p o i n t b u t h a s r e t u r n e d ; a l l f o r w a r d d i s c o u n t s , h o w e v e r , a r e l o w e r t h a n t h e y w e r e a w e e k a g o . T h o u g h t h e m o o d o f t h e m a r k e t k e p t i m p r o v i n g a l l w e e k , t h e e x t e n t o f t h e f a l l i n b i l l y i e l d s w a s s u r p r i s i n g a n d c a u s e d m o r e t h a n t h e u s u a l s p e c u l a t i o n a b o u t t h e G o v e r n m e n t o f C a n a d a i s s u e e x p e c t e d t h i s w e e k e n d . S p e c u l a t i o n a l s o c e n t r e d o n p o s s i b l e c h a n g e s i n t h e U . S . d i s c o u n t r a t e a n d i n t h e C a n a d i a n b a n k r a t e . T h e r a t e o f i n c r e a s e i n t h e m o n e y s u p p l y , b r o a d l y d e f i n e d , r o s e a t a s e a s o n a l l y a d j u s t e d a n n u a l r a t e o f 2 2 % f r o m S e p t e m b e r t h r o u g h J a n u a r y , i n t h e 3 m o n t h s N o v e m b e r t o F e b r u a r y t h e c o m p a r a b l e r a t e o f g r o w t h w a s 1 7 % , w h i c h s l o w e d d o w n t o 9 % i n F e b r u a r y . G O V E R N M E N T O F C A N A D A TREASURY B ILLS A v e r a g e T e n d e r R a t e s 9 1 D a y s 1 8 2 D a y s M a r . 1 1 / 7 1 3 . 3 4 % 3 . 4 4 % M a r . 4 / 7 1 3 . 9 8 4 . 0 3 F e b . 1 1 / 7 1 4 . 6 1 4 . 6 8 CURRENT MARKET RATES BONDS D U E WITHIN O N E Y E A H Amount o/s $ Million Coupon 2 2 5 2 0 0 3 5 0 7 5 2 0 0 6 5 8 6M Maturity A p r . 1 / 7 1 A p r . 1 / 7 1 J u n e 1 / 7 1 J u n e 1 / 7 1 O c t . 1 / 7 1 Market 1 0 0 . 0 0 - 1 0 1 0 0 . 0 1 - 1 1 1 0 0 . 0 0 - 1 0 1 0 0 . 6 5 - 7 5 1 0 0 . 8 5 - 9 5 Y i e l d S H O R T T E R M N O T E S A N D D E P O S I T S PROVINCIAL B ILLS & N O T E S CHARTERED B A N K DEPOSIT RECEIPTS BANKERS ' ACCEPTANCES T R U S T COMPANY DEPOSIT RECEIPTS F INANCE COMPANY N OTES ( D i s c o u n t R a t e ) A s s o c i a t e s A c c e p t a n c e C o m p a n y A v c o F i n a n c i a l S e r v i c e s ( C a n a d a ) L i m i t e d B e n e f i c i a l F i n a n c e C o m p a n y o f C a n a d a L t d . C o m m e r c i a l C r e d i t I n t e r n a t i o n a l L i m i t e d C h r y s l e r C r e d i t C a n a d a L t d . G e n e r a l M o t o r s A c c e p t a n c e C o r p o r a t i o n I A C L i m i t e d I n t e r n a t i o n a l H a r v e s t e r C r e d i t C o r p n . U n i t e d D o m i n i o n s C o r p o r a t i o n ( C a n a d a ) CORPORATE N O T E S B e l l C a n a d a T . E a t o n A c c e p t a n c e C o . L i m i t e d F i r e s t o n e T i r e & R u b b e r C o . o f C a n a d a L t d H o n e y w e l l H o l d i n g s L i m i t e d I m p e r i a l O i l L i m i t e d M a c M i l l a n B l o e d c l L i m i t e d M a s s e y - F e r g u s o n F i n a n c e C o . o f C a n a d a L t i N a t i o n a l C a s h R e g i s t e r C o . o f C a n a d a L t d . S i m p s o n s - S e a r s L i m i t e d A. E. A m e § $t Co. Limited 3 0 - 5 9 D a y s 6 0 - 8 9 D a y s 9 0 - 1 7 9 D a y s 1 8 0 - 2 6 9 D a y s 2 7 0 - 3 6 5 D a y s % % % % % 4 . 0 0 - 4 . 2 0 4 . 4 0 - 4 . 5 0 4 . 6 0 - 4 . 7 5 4 . 7 0 - 4 . 9 0 4 . 9 0 - 5 . 0 0 4 . 0 0 - 4 . 7 5 4 . 2 5 - 4 . 7 5 4 . 5 0 - 5 . 0 0 4 . 7 5 - 5 . 2 5 4 . 7 5 - 5 . 2 5 4 . 3 0 4 . 4 0 — — — 4 . 2 5 - 4 . 7 5 4 . 5 0 - 5 . 0 0 4 . 7 5 - 5 . 0 0 5 . 0 0 - 5 . 2 5 5 0 0 . - 5 . 5 0 4 . 3 7 5 4 . 3 7 5 4 . 3 7 5 4 . 3 7 5 4 . 3 7 5 5 . 0 0 5 . 1 2 5 5 . 2 5 5 . 2 5 5 . 5 0 4 . 3 7 5 4 . 3 7 5 4 . 3 7 5 ( t o 1 2 0 ) — • — o n a p p l i c a t i o n 4 . 6 2 5 ( 9 0 - 1 1 9 ) 4 . 8 7 5 ( a t 1 2 0 ) 4 . 8 7 5 4 . 8 7 5 4 . 5 0 4 . 6 2 5 4 . 6 2 5 4 . 7 5 4 . 8 7 5 4 . 2 5 4 . 2 5 4 . 3 7 5 4 . 5 0 4 . 5 0 4 . 2 5 4 . 2 5 4 . 3 7 5 4 . 3 7 5 4 . 6 2 5 4 . 7 5 4 . 7 5 4 . 8 7 5 5 . 0 0 6 . 0 0 ( a t 3 0 0 ) 4 . 7 5 4 . 7 5 4 . 8 7 5 4 . 8 7 5 5 . 0 0 D e m a n d 3 0 D a y s 6 0 D a y s 9 0 D a y s 1 8 0 D a y s — 4 . 2 5 4 . 2 5 — — — 4 . 2 5 4 . 2 5 4 . 2 5 — — 4 . 5 0 4 . 6 2 5 4 . 6 2 5 — 4 . 2 5 4 . 5 0 4 . 6 2 5 4 . 6 2 5 4 . 6 2 5 — 3 . 8 7 5 4 . 0 0 4 . 0 0 — 4 . 7 5 4 . 8 7 5 5 . 0 0 5 . 1 2 5 — d . 5 . 1 2 5 5 . 3 7 5 5 . 5 0 5 . 6 2 5 5 . 7 5 4 . 2 5 4 . 3 7 5 — — — 4 . 3 7 5 4 . 5 0 4 . 6 2 5 4 . 7 5 — B u s i n e s s E s t a b l i s h e d W 8 9 

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